Potential ConstructionClaims and Damages

OVERVIEW OF POTENTIAL CONSTRUCTION CLAIMS AND DAMAGES
A. B. C. Claims Under the Contract............................................................. 1 Other Types of Claims ................................................................... 1 CONTRACTOR’S CLAIMS FOR DIRECT COSTS, PROJECT OVERHEAD AND IMPACT COSTS........................ 1 1. 2. 3. 4. 5. 6. D. Formal and Constructive Changes ..................................... 2 Inefficiency and Disruption Claims ................................... 8 Acceleration Claims ......................................................... 11 Delay and Schedule Extensions Claims........................... 13 Wrongful Termination Claims ......................................... 18 Quantum Meruit ............................................................... 19

OWNER’ S CLAIMS FOR DEFECTIVE WORK AND DELAYS ...................................................................................... 20 1. 2. 3. Parties Sued by Owner ..................................................... 20 Actions or Events Giving Rise to Owner Claims............. 21 Pricing of Owner’s Damages ........................................... 22 Mechanic’s Lien Claims................................................... 26 Bond Claims..................................................................... 35 STATUTORY CLAIMS – UNFAIR TRADE PRACTICES AND CONSUMER PROTECTION LAWS............................................................................... 47 TORT ACTIONS............................................................. 50 “No Damages for Delay” Clauses.................................... 57 Pay When Paid Clauses.................................................... 58

E.

OTHER TYPES OF CONSTRUCTION CLAIMS ..................... 26 1. 2. 3.

4. F. 1. 2.

CONTRACTUAL LIMITATIONS ON LIABILITY.................. 56

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OVERVIEW OF POTENTIAL CONSTRUCTION CLAIMS AND DAMAGES

A.

CLAIMS UNDER THE CONTRACT

Disputes often arise between subcontractors, contractors and owners regarding performance of the project. The potential number of players in a construction dispute is limited only by the number of parties involved with a particular project. Expectations of owners, contractors, subcontractors, architects, engineers, or materialmen may be disappointed and disputes may arise at any time between the first bid and the last bill. Owners take a dim view of nonperformance by contractors, subcontractors, and others, who take an equally dim view when their performance is not rewarded by timely payment by the owner. Moreover, disputes frequently occur over the scope, timing and quality of work actually performed and materials actually delivered. Contractors’ contract-based claims are addressed in Section C below, and the Owner’s contract claims are addressed in Section D below.
B. O T H E R T Y P E S O F C L A I M S

Complications arise when the claimant has not directly contracted with the party against whom claimant wishes to file its claim. For example, claims may arise between an owner and a subcontractor or materialmen. Under these circumstances, the subcontractor has no cognizable claim against the owner for breach of contract because no privity exists between the parties. In Pennsylvania, as in most states, these types of claims are often brought in the form of mechanics’ lien or bond claims, in the appropriate circumstances. Other claims may arise with even more remote third parties, either against the project owner or in some cases against one another, such as financing entities, end users and other members of the construction process for whom there are no contractual remedies. These claims are often brought as tort claims (for example negligence, fraud and strict products liability), or statutory claims (for example, under consumer protection statutes or the Uniform Commercial Code). These claims are addressed in Section E, below.
C.

CONTRACTOR’S CLAIMS FOR DIRECT COSTS, PROJECT OVERHEAD AND IMPACT COSTS

This section generally discusses the types of damages recoverable for various types of contract claims. The concentration herein is on the actions and events that may be compensable and result in claims by the contractor or owner when these increased costs can be established with relative certainty, liability can be determined, and liability and increased costs may be linked. These various events can be classified into the following general categories: Formal and Constructive Change Order Claims 1

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Disruption Claims Acceleration Delay and Extension Claims Termination Claims Quantum Meruit Formal and Constructive Changes

Any discussion on liability for changes assumes that the work was performed, and that it was outside the scope of the original contract. If either of these events is not true, a contractor is not entitled to recover on a claim. The analyses of issues involved in the pricing of direct costs and/or disruptions, delays related to formal change orders are similar to those involved with claims for constructive changes. The only major difference is that in a formal change order the owner has, in essence, admitted that something is owed for the changed work. Many times the contract provides the pricing scheme for the change. On other occasions, the owner waits for the contractor’s pricing quote. Therefore, the pricing of direct cost related to formal changes is similar to the pricing discussion regarding “constructive” changes. Any conduct by a contracting officer (or other representative of the owner authorized to order changes), or any event which is not a formal change order, but which requires performance of work different than anticipated or prescribed by the original contract, may constitute a “constructive” change order. There are a great many actions and events that can result in constructive changes to contract work. Set forth below is a partial list of these actions and events. The reader will observe that many of the items overlap, or in some instances are caused by each other: rejected change orders, including differing site conditions, changed or defective specifications, late or excessive inspection, or rightsof-way, permits and other site access problems suspension or delay acceleration inefficiency or loss of productivity disruption.

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Direct costs as defined in this section include only the costs of labor, equipment and materials needed to perform the actual work within the scope of
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the change. It does not include the consequential effect of changes such as costs for the disruption and inefficiency created by change orders; costs of acceleration of work; and costs as a result of project extensions. These “ripple effect” costs are explained below.
a.

Use of Forms in Pricing Changes

A contractor should develop and utilize standard forms to calculate and submit pricing of the direct cost of changes. Forms should be based on and include typical work performed by the contractor. The forms force the contractor to critically examine all potential effects of the change with respect to direct costs. Therefore, all direct costs of labor, equipment, materials and other costs should be captured and associated with the work as described on the forms. This is so whether the change is being priced on a pre-performance basis or on an after-thefact basis. Other direct costs associated with the change such as field overhead, bond costs, insurance, interest and profit should also be noted on the forms. Once the direct costs of the change are calculated, they should be summarized and transmitted to the owner or its agent via a standardized transmittal letter. The standardized transmittal letter should, of course, identify the project; provide a brief description of the work; state the total direct costs for the work and attach a copy of the forms showing the breakdown of costs for the work; and should provide for a time limit for the owner to either accept or reject the pricing of the work. If the owner simply holds on to the pricing for the change without approving and paying it, and if the amount is substantial, then the contractor may not be fully compensated by payment several months after the submittal because of financing charges or other costs which have increased on the change during the interim period. In addition, the form transmittal letter should identify any schedule extensions requested or needed as a result of the change. Documentation supporting the request should be attached. It is also best to identify in the letter that the price assumes that the work will commence by a certain date, and that it is expected the work will be completed by a certain date. This allows for further clarification on the pricing in the event subsequent occurrences prevent the scheduled start or completion of the changes.

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b.

Direct Labor Costs

Direct labor costs should be based on actual or anticipated increased costs of the various craftsmen, operating engineers, teamsters, laborers, etc. Rates of pay may be dictated by contract terms, or if not in the contract may be supported by various union wage scales or other supportable bases. Costs of supervision should also be calculated and noted. Regular time and overtime work should be noted, and if overtime rates are requested they should be justified on the basis that the work could not be completed on regular time, that no time extension was granted, or other appropriate basis. Documents to support labor charges include payroll records, invoices, estimates, bid takeoffs, job diaries, and other daily project reports.
c.

Direct Equipment and Material Costs

Equipment costs may be increased due to additional equipment needed to perform the work. Charges for equipment usage may be based on contract terms, or if not specified in the contract may be based on rental invoices or hourly rates. The appropriate price to charge is the substantiated, increased time-related costs associated with owning or providing equipment on the site to perform the work within the change. Payroll reports for operating engineers may provide evidence of when equipment was used. For contractor owned equipment, internal rates may have been developed based on the total costs of owning the equipment spread out over the useful life of the equipment. Costs such as depreciation, insurance, taxes, storage and administrative costs should be included in the rate. The rate is usually expressed in hourly, daily or weekly costs of operation. However, only excess costs incurred as a result of the change should be included. If, for example, a piece of equipment is purchased and is to be used during the project and then disposed of, it may be difficult to accurately price the change with respect to equipment usage. Purchase of the equipment is a one-time charge unrelated to equipment usage or project duration and should not be included as a cost of the change, except if the change decreases the expected resale value of the equipment. The appropriate cost would be the substantiated decrease in the resale value. The contractor should also be aware that government entities frequently ask to audit such information, and, in the absence of an audit, will allow only the standard “book” or market rate. When contractor-owned equipment is fully depreciated (equipment with little or no book value), the contractor should still recover excess costs of equipment usage because the equipment is a valuable, productive resource. The appropriate measure of value may be industry-wide time-related costs of equipment. Two common sources are the (1) Associated General Contractors of America Contractors Equipment Manual (AGC manual); and (2) the Rental Rate Blue Book for Construction Equipment. Average hours of economic life; average hours of use per year; average depreciation and replacement costs; and average
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costs of operation, repair and maintenance costs can be calculated from these sources. Actual job conditions may require that these averages be adjusted either up or down. The rates do not include job site or all home office overhead costs. However, because depreciation, taxes and storage can be considered part of home office overhead, to the extent possible these costs should not be counted twice (in the cost pool for home office overhead claims and again in the claim for equipment usage).
d.

Job-Site Overhead

Job-site overhead is frequently referred to as “general conditions” or “project administration.” These costs include costs of on-site project management and administration, trailer rentals, storage charges, utilities, etc. Contracts usually provide for percentage mark-ups on labor and other direct costs to account for job-site overhead. If need be, the contractor can support its clam by reference to bid documents and estimates, or industry practice. Further support can be shown by actual costs for additional time and effort spent on meetings and discussions regarding estimating and engineering with respect to the change. Unanticipated additional manpower needed to perform work may also result in additional expenditures for small tools, supplies, consumables or other miscellaneous items that were carried as general conditions.
e.

Interest Claims

The financing of unreimbursed project costs as a result of changes can have a significant impact. Interest charges may be appropriate to recoup financing costs or the lost opportunity to utilize internal funds in a manner other than as planned. The key factors to quantifying a claim for interest is to determine (1) the period over which the interest is computed; and (2) the rate or “cost of money.” These factors may be set forth in the contract documents or by applicable local or federal regulations. For example, Pennsylvania provides for the recovery of postjudgment interest at 6%. 41 P.S. § 201. The New York statutes specifically allow for a claim of pre-award interest at 9%. See C.P.L.R. § 5001, 5004. Under Pennsylvania law, if the amount of damages is liquidated or a sum mathematically ascertainable, and the onset of damages can be set with relative certainty, prejudgment interest will be permitted if the defendant was in default. See Citizens’ Natural Gas Co. v. Richards, 130 Pa. 37, 18 A. 600 (1889); Sharp v. Coopers & Lybrand, 649 F.2d 175 (3d Cir. 1981), cert. denied, 455 U.S. 938, 102 S.Ct. 1427 (1982). Pennsylvania courts will also allow interest on contract damages prior to judgment as a matter of right as “compensation for delay.” Daset Mineral Corp. v. Industrial Fuels Corp., 473 A.2d 584, 595 (Pa. Super. 1984). It is important to provide evidence, however, that the fault for nonpayment rests with the defendant, it is an ascertainable amount, and the date the money was due can be set with reasonable certainty. See Marrazzo v. Scranton Nehi Bottling Co., 438 Pa. 72, 263 A.2d 336, 337 (1970). See also Frank B. Bozzo. Inc. v. Elec.
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Weld Div., 498 A.2d 895, 899 (Pa. Super. 1985); JMB Realty Corp. v. Allright Co., 34 Phila. Co. Rptr. 229, 252 (Pa. Cmwth. June 4, 1997). The contractor may refer to change order logs as a basis to set the date of the onset of the claim for interest. In other areas where the timing of the occurrence is not as well established, such as claims for acceleration or inefficiency, the contractor should prepare a cause effect analysis to show whether and when interest is appropriate. This can be done by a cash-flow analysis to determine whether the contractor was actually “out of pocket,” and if so to what extent and for how long. Sources of financing (internal vs. borrowings) should be documented. The ultimate goal is to show periods of negative cash flow or loss of use of funds that were due to compensable delays. The appropriate rate for postjudgment and prejudgment interest is stated as the “legal” rate of 6% simple annual interest. Carrolla v. City of Philadelphia, 735 A.2d 141, 146 (Pa. Cmwth. 1999); Daset Mineral Corp. v. Industrial Fuels Corp., 473 A.2d 584, 595 (Pa. Super. 1984); 41 P.S. § 202. However, if a contract provides for a specific rate of interest higher or lower than the legal rate, the specified rate should apply for all prejudgment interest. See O’Brien & Gere Eng’r., Inc. v. Taleghani, 525 F. Supp. 750 (E.D. Pa. 1981) (12% applied); Reliance Security Service, Inc. v. 2601 Realty Corp., 557 A.2d 418, 419 (Pa. Super. 1989) (18% applied). However, the court in Reliance explained that once a judgment against the creditor had been obtained, the rate of interest on the judgment was to be 6% per annum, even if the contract provided for a higher rate of interest. If funds are obtained internally, then the appropriate rate may be argued to be the lost opportunity to use those funds elsewhere. The success of this argument is not certain.
f.

Profit

In addition to being entitled to recover excess costs attributable to a party’s breach of contract, Pennsylvania courts allow an injured contractor to recover the profit anticipated under the contract if the evidence is sufficiently certain and definite to afford a basis on which to estimate its extent. There are at least some exceptions. For example, in C. J. Langenfelder, infra, 404 A.2d 745, the contractor did earn the total profit contemplated by the contract, but sought an additional markup of 10% for profit on damages of increased labor and equipment costs resulting from delays. The court held that the 10% mark-up on proven damages, which was over and above the anticipated profit on the job, was not recoverable because it was a profit or gain prevented by the breaches of contract. The court in Commw. Dept of Highways v. S. J. Groves & Sons, Co., 20 Pa. Commw. 526, 343 A.2d 72, 78 (1975) also followed the rule that profits on out-of-pocket losses may not be appropriate where the contractor otherwise received its full anticipated contract profit. The project was delayed 14 weeks
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when the Commonwealth failed to provide site access. The court awarded damages for the delay, plus it affirmed the Board of Arbitration’s mark-up of 10%, although the Board did not explain whether the mark-up was to cover overhead, profit or both. The full contract price plus excess costs were paid, but the contractor argued it was entitled to additional profit on its excess costs. The court denied the recovery for profit on the excess costs for the following reason: The total contract was to be performed in 280 working days and, by incurring the costs for extra time and labor herein recovered, [the contractor] completed the work on time. Whatever profits were anticipated on the total contract were presumably duly received, there being no evidence to the contrary. We know of no rule which provides that a contractor is entitled to receive a profit on each and every item of work on a contract of this nature. Id. The Pennsylvania Supreme Court’s opinion in Exton Drive-In. Inc. v. Home Indem., Co., 436 Pa. 480, 261 A.2d 319 (1969) explains the tough burden a new and untried business must meet to recover lost profits from untimely performance by a contractor. There, a contractor did not timely complete all of its work to grade and pave a drive-in. The court denied the owner’s request for loss of anticipated profits and stated that “the anticipated profits of a new and untried business which were attributable solely to the unfinished condition of the business premises were too speculative to provide a basis to award damages.” See also Delahanty v. First Pennsylvania Bank, N.A., 318 Pa. Super. 90, 117-26, 464 A.2d 1243, 1257-61 (1983) (burden of proof is very high with respect to new business profits). Lost profit may be awarded, however, if sufficient and proper proof is provided. The traditional method is to present evidence of past profitability in an established business. Draft Systems, Inc. v. Rimar Mfg., Inc., 524 F. Supp. 1049, 1055 (E.D. Pa. 1981); Mass. Bonding & Ins. Co. v. Johnston & Harder, Inc., 343 Pa. 270, 279, 22 A.2d 709, 714 (1941). It is clear, however, that “under Pennsylvania law, a plaintiff may not recover for loss of profits to a business because of customer dissatisfaction or loss of goodwill.” Neville Chem. Co. v. Union Carbide Corp., 422 F.2d 1205, 1225 (3d Cir. 1970), cert. denied, 400 U.S. 826 (1970); National Controls Corp. v. National Semiconductor Corp., 833 F.2d 491, 495 (3d Cir. 1987). The rate of profit may be set forth in the contract; or the bid rate of profit; the contractor’s historical rates; or industry rates. No single profit rate is correct for every claim. The appropriate rate should be determined by the nature of the industry and job, and the risk inherent in the work. For example, if changes dramatically delay or disrupt the work, it does not follow that a contractor which has bid a low profit should be limited to that low profit on changes because the project and conditions as they actually existed may not be as the were anticipated to be at the time of bid.
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g.

Legal Fees

Legal fees can represent a significant expense to parties involved in claim disputes. As such, claimants may seek to recover these costs through the claim, contending that these costs would not have been incurred if not for the unlawful acts of the defendant. However, courts typically apply the “American rule”: litigants cannot recover expenses incurred in litigating disputes in absence of contract language or statutes to the contrary. See In re Mailers Unlimited, Inc., 6 B.R. 238, 240 (Bankr. E.D. Pa. 1980) (“the ‘American Rule’ precludes the await of attorney’s fees except on a showing of bad faith or on specific statutory authorization”). The contract may allow for the award of attorneys’ fees as damages. There are limited exceptions to this rule, for example, where legal expenses are incurred in a lawsuit because the breach of contract of another person caused the person who is seeking the attorney’s fees to be in litigation. See C. J. Langenfelder & Son. Inc. v. Commw. Dept. of Transp., 44 Pa. Commw. 585, 404 A.2d 745 (1979). In Mercer Raceway Inc. v. Commw. Dept. of Transp., 435 A.2d 1338, 1339 (Pa. Commw. 1981), Mercer alleged that PennDOT breached its lease by invading the electrical right-of-way which was not leased to it. As a result, an employee of PennDOT was injured and cited PennDOT, Mercer and others. This scenario sufficiently stated a case where Mercer would be entitled to legal fees from PennDOT to defend the lawsuit. Another exception is in extreme cases where a party employs bad-faith litigation tactics or claims which are without merit and needlessly drive up costs of litigation. In Chervenak, Keane & Co. v. Hotel Rittenhouse Assoc., 477 A.2d 487 (Pa. Super. 1984), a consultant sought court enforcement of an arbitrator’s award against an owner who refused to pay. The court found that the owner’s use of various procedural tactics to delay payment were instituted without merit and served only to cause annoyance and acts. As a result, the court affirmed an award of counsel fees and costs.
2.

Inefficiency and Disruption Claims

In general, disruption can be described as the result of being forced to perform contracted work in a manner different and less efficient than originally planned. When a contractor bids a project, the bid costs for the work are based on assumptions concerning construction procedures, levels of manpower, and sequences of work activities. Any deviation from these planned factors may result in an increase in the costs required to perform the contracted work. For example, numerous and unexpected changes can cause consequential affects of lowering productivity of workers because of stop-and-go activities; trade stacking; interferences with other trades; restricted access; extra shifts, over-manning; and other disruptions to the orderly progress of the work. If attributable to actions or inactions of the owner, such disruptions and the resulting cost growth often give rise to disputes and claims for equitable adjustment.
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Other examples of disruption to project productivity include excessive inspection (in terms of frequency and/or the stringency of requirements). Inspections interrupt worker productivity in two ways. First, during the period of inspection or testing, workers may be denied access to work areas and required to interact with inspectors, wasting productive time. Therefore, excessively frequent testing and inspection can result in unplanned levels of “down” time. Second, and perhaps more importantly, overly strict inspection often results in significant amounts of rework or repair of completed areas. Deviation from planned sequence or levels of manpower can also damage efficiency and productivity. Virtually any task has an optimum sequence, and a level of manning that will provide the most cost-effective performance. Exceeding that level reduces productivity due, for example, to shortages of workspace, trade stacking and resulting confusion. Under-manning the optimum level may destroy the efficiencies of crew specialization and the learning effect, and wastes time in worker “transition” between activities. Any factor, therefore, which prevents a contractor from working at planned optimum sequence or staffing levels may deteriorated productivity and raised the cost of performance. See Blake Constr. Co., Inc. v. C. J. Coakley Co., Inc., 431 A.2d 569 (D.C. App. 1981). Similarly, a deficiency in other construction resources, such as tools, equipment or construction materials, can retard the rate of production. Crews working without the required level of support from the equipment and materials required to perform the work cannot achieve planned rate of production. Inefficiency claims, then, attempt to quantify the substantiated incremental costs incurred due to losses in productivity encountered in construction. It is vitally important, however, that the contractor reserve its right to seek recovery of the costs of “ripple effects,” if any, from excessive changes at the time it signs off on change orders. If the contractor fails to reserve such rights the owner may later claim that the contractor waived such claims by failing to include costs associated with a change in the change order. For instance in Glasgow, Inc. v. Commw. Dept. of Transp., 529 A.2d 576, 580 (Pa. Commw. 1987), a contractor sought delay damages from PennDOT due to additional work orders, redesigns and other delays in the construction of a bridge. The contractor sought recovery of all of its costs overruns, including costs of extra work. However, the contractor failed to negotiate for additional compensation resulting from the changes pursuant to the terms of the contract at the time it signed off on the change orders. The court ruled that the contractor could not recover any additional monies for the extra work. A simple statement by the contractor in the change order such as the following should suffice to preserve claims for costs not set forth or known when a change order is issued: “The above change request/order is priced only to include those direct costs of the change which can be identified at this time. Should it be determined at a later date that the change creates an impact such as
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delays, disruptions or other causes beyond our control, we reserve the right to forward those costs at a later time.” Probably the most successful method of calculating loss of efficiency is to present objective evidence of work productivity during a “normal” period on the project and compare this measure with the productivity during the disrupted period (the so-called “measured mile” approach). See Natkin & Co. v. George A. Fuller Co., 347 F. Supp. 17 (W.D. Mo. 1972) (lost productivity computed by comparing actual productivity rates before and after the impact); General Ins. Co. of America v. Hercules Constr., 385 F.2d 13 (8th Cir. 1967); Clark Concrete Contractors, Inc. v. General Services Admin., GSBCA No. 14340 (March 15, 1999) (upheld one of “measured mile” approach even where compared work was not identical). In Luria Bros. & Co. v. United States, 369 F.2d 701 (Ct. Cl. 1966), the court noted that mere expert testimony on an efficiency loss projection is insufficient; comparison of similar work activities on the same project or similar projects, or other corroborative evidence is necessary. The emphasis here is to identify the actual rate of production that the contractor would have realized if not for the claimed hardships. The time and activity periods compared should be broken down into the smallest detailed components; the normal and affected work should be as similar as possible; and the trial period should be unaffected and sustained. For example, a contractor installs only 15 sheets of drywall per person each day in an affected area, but installs 20 sheets per person per day in an unaffected area. The claim would be based on the increased costs of 5 sheets per person per day in the affected area. Critical analysis of this type of claim includes comparison of the type of work involved; length of the base periods for comparison; whether material shortages were a problem; whether labor shortages were a problem; and other factors which may have caused the difference in the productivity rates such as weather. Once the trial period productivity measure(s) have been identified, calculated and adequately supported, it is important to assess the overall reasonableness of that rate of production, in light of industry standards, bid productivity, historical productivity, and the resources available to commit to the effort. Any trial period rate of productivity that differs substantially from the bid level of efficiency should be analyzed. Similarly, standard industry productivity rates may not consider the unique aspects of the subject project. However, they can be used as a general gauge of the reasonableness of the selected rates. After the predicted productivity rate is determined, it is compared to the actual productivity rates incurred on affected work. Consistent with the causeeffect claim methodology, the comparison is made only for identified, supported periods of impact. To compare the trial period efficiency with work that cannot be established as affected or damaged results again in a meaningless mathematical calculation.
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If there are no unaffected periods during the project from which a “normal” rate of productivity can be derived, an alternative comparison can be obtained by using identical or similar work on past contracts. Again, the conditions during the prior work and the affected work should be as similar as possible to remove variables that could account for the difference. Another guide in determining inefficiency is the use of published industry guide manuals setting forth expected rates of productivity. This, however, is not as persuasive because there is no indication whether this particular contractor is either more or less efficient than the industry average. Other bases for determining inefficiency can be other bidders’ estimated productivity rates or the owner’s estimate. This type of pricing should be substantiated by data showing that the contractors’ bids were reasonable and in accordance with industry practice. In addition to labor inefficiency, a contractor may be able to document equipment inefficiencies. For example, differing site conditions such as extremely muddy or wet soil can slow the equipment on the project. Costs recoverable for equipment inefficiency can include additional costs of maintenance, repair and operating costs. Disrupted labor may also lead to higher loss or breakage of tools. These costs can be quantified in the same manner as labor: a comparison of predicted rates to affected rates. As with labor inefficiency claims, claims for increased equipment, small tools and supplies due to project disruptions are appropriate only for periods or affected activities.
3.

Acceleration Claims

Acceleration is the group of activities undertaken to make up time (production) in order to meet the originally planned completion date or to complete a project earlier than planned. Acceleration can take many forms, such as working longer shifts (overtime labor), adding second or third shifts, increasing levels of manpower and equipment, or performing various tasks concurrently. The requirement to accelerate may originate from three sources:
a.

Contractor-Directed Acceleration

In some instances, the contractor may fall behind schedule due to factors that are not the responsibility of the owner, and may choose to accelerate his efforts to meet the established deadline. If he determines that the costs of acceleration would be exceeded by the costs of project delays (possibly including liquidated damages imposed by the owner, the contractor’s own extension costs and failure to meet other contractual obligations that require the committed manpower and equipment), the contractor may decide to absorb the acceleration costs as the least costly alternative. In this case, the liability for the delay and the
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acceleration costs clearly lie with the contractor, and disputes or claims would be inappropriate.
b.

Owner-Directed Acceleration

In other cases, such as a compensable delay, the owner may decide that it is in his best interest to pay the acceleration costs of the contractor rather than face the costs associated with delay. The owner then will issue an order to accelerate. Here again, the liability for the decision to accelerate and the resulting costs is clear and should not cause disputes other than perhaps the quantification of the associated costs.
c.

Constructive Acceleration

Constructive acceleration usually occurs where the original or change work must be completed within the original contract period despite the existence of excusable and compensable delays. The owner forces the contractor to accelerate by holding firm to the completion date without officially directing acceleration. The dispute centers on the cause for the need to accelerate on the project. In order to prevail on an acceleration claim, a contractor first must establish that he was ordered or forced to accelerate by the owner. Thus, he must prove that the earlier delays giving rise to the acceleration were excusable, that an extension of time was requested and denied, and that he was directed to accelerate or otherwise meet the contracted date of completion. Once established, he then must demonstrate that he actually accelerated performance and incurred added costs as a result. Unlike the costs of inefficiencies, certain acceleration costs may not be as difficult to isolate in the contractor costs records. For proven instances where extra labor equipment was brought onto the job to step up the pace of performance, or where premiums were paid to expedite manufacture or delivery of material, invoices and/or supporting documentation setting forth the related costs should be available. Acceleration claims frequently are joined with claim for loss of efficiency because productivity may be lowered when worker are required to work overtime. Pricing of the claim for loss of efficiency is described above. The most difficult aspect of establishing acceleration claims may be determining the reasons for and compensability of acceleration efforts. Often, accelerated work is self-imposed by the contractor to compensate for his own delays or inefficiencies in performance. Acceleration claims are appropriate only in instances where the owner has mandated explicitly or implicitly that the contractor meet certain dates of completion, despite the existence of otherwise excusable delays.
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4.

Delay and Schedule Extensions Claims

Construction delays are very costly. Extended costs for delays are a common and hotly contested element in pricing. Quantification of delay damages requires (1) an analysis to determine the type of delay; (2) time analysis of the delay period; (3) an analysis of the cause and liability for the delay; and (4) an analysis to determine the costs related to the delay.
a.

Types of Delays

Project delays can be segregated into three types regarding their impact on the construction schedule:
(i)

Direct Delay

A direct delay represents a situation in which a work stoppage or disruption slows the contractor’s progress and extends the time required to complete the contracted work. It is composed of a discrete delay to an activity on the critical path. Examples of events that could cause a classic delay are work stoppage orders, lack of access to work areas, failure to receive materials, insufficient manning levels, strikes, etc.
(ii)

Concurrent Delay

Concurrent delays are two or more unrelated delay periods occurring simultaneously, each of which independently affects the project end date. The more typical situation encountered is where two or more delays overlap at some point during their existence. The analysis of overlapping delays is especially difficult because the individual delays can differ as to responsibility (owner vs. contractor), duration, impact on critical path and the ability to substitute other work steps for the precluded activities. Each party must bear its own losses, and the contractor has the burden of proving the costs attributable to the owner and to the contractor, and if that is not possible no damages are recoverable.
(iii)

Serial Delays

Serial delays are a chain of individual delays. These delays may arise from different causes, but impact and extend the same activities. In serial delays, one delay can give rise to or exacerbate the impact of a subsequent delay, such as a delay in the receipt of materials extending project performance into a cold or rainy period.
b.

Causation and Compensability

Delays are classified in terms of causation and compensability.

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(i)

Excusable/Compensable

Not the fault of the contractor, these delays are the result of actions or inactions by the owner or its representatives, or events for which the owner is responsible, and for which the contractor is entitled to be compensated.
(ii)

Excusable/Non-Compensable

The fault of neither owner nor contractor, these delays are due to events outside of the control of both parties-causes such as acts of God or labor strikes. As such, neither owner nor contractor is generally liable for damages. Thus, damages are non-compensable. However, the contractor may be entitled to an extension of time to complete its work.
(iii)

Non-Excusable

Such delays are due to actions/inactions of the contractor, such as poor productivity, excessive repair or rework of defective work, or unreasonable failure to plan and coordinate work effectively. The owner, in addition to not being liable for project time extensions and contractor delay damages, may be entitled to liquidated or actual damages based upon the provisions of the contract.
c.

Time Analysis

Time analysis involves a thorough examination of the various activities o the job, pinpointing deviations from planned performance, and then quantifying the delay. Time impact analysis requires first that the contractor review project drawings, specifications and other contract documents as well as schedules, progress logs, and similar records. Next, planned and actual performance are compared in the form of CPM network schedules to identify critical deviations. An analysis is required of three basic types of CPM schedules. The contractor reviews the following schedules: “As-planned” schedule. This schedule represents the planned sequence and timing of original contract work. It is important that this schedule be reviewed for reasonableness, and determined to be a realistic, achievable plan. “As-built” schedule. This schedule sets forth the various project activities as they were a actually performed, reflecting the actual sequence and duration of each activity, and the actual interrelationships among activities. As the as-planned and as-built schedules are compared, deviations, are identified. These deviations represent changes in the planned performance. As each impact is identified, the as-planned schedule is revised to reflect the impact,
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yielding an as-adjusted schedule, which will then be compared to the as-built to identify further impacts. To develop as-adjusted schedules, the original as-planned schedule is compared with a final as-built schedule to determine the overall magnitude of the project delay and to identify major discrepancies. Analysis centers on activities appearing on the critical path, but other paths are also studied in case of potential shifting of critical paths an possible resequencing, and to determine the largest schedule variance along alternative paths. Comparisons of the schedules will reveal all major variances. After specific activities and time periods have been pinpointed through the network analysis, project records and interviews can be utilized to determine why these delays occurred and who bears the responsibility of the time extension.
d.

Costs of Delay

The object of pricing an extension claim is to quantify the increased costs that were incurred only as a result of actions by the responsible party that caused a longer than planned period of performance. There typically are four types of damages associated with delay: (1) extended project costs; (2) escalation; (3) inefficiency; and (4) unabsorbed overhead.
(i)

Extended Project Costs

Throughout a period of delay the contractor continues to incur direct costs which do not result in productive work. These costs which could not have been avoided by good management are recoverable. For example, it may not be reasonable, or even possible, for a contractor to transfer resources to another job because the extent of the delay is unknown or he has no other jobs to which he can reasonably relocate. Unavoidable costs of idle labor that do not result in productive work are recoverable. This can include the full salaries and fringes of supervisory personnel if it is not reasonable to discharge them or lay them off. Labor charges for hourly workers can also be recovered if they cannot be discharged without seriously risking later unavailability and there are no other temporary job assignments. Costs for extended or idle equipment are also recoverable. As explained previously, rates for rented equipment and contractor owned equipment may be determined. The appropriate rates are the time-related costs associated with owning or providing the equipment to the site. However, charges for idle equipment should be reduced because idle equipment does not depreciate at the same rate as active equipment, and does not have major repairs or overhead associated with active equipment. Extended job-site overhead is also recoverable. Then costs would include office trailers, temporary toilets, security, etc. An accepted method of quantifying Michael R. Libor 15
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these costs is to establish a daily rate for time-related costs. The daily rate can then be applied to the period of compensable delays. The costs included in the pool of job-site overhead costs should be screened, however, to delete: (1) nontime-related costs; (2) costs that do not benefit the subject contract; and (3) costs included elsewhere in the claim. Examples of non-time related costs are onetime purchase costs of photocopiers; telephone hook-up charges; and utility hookup charges. These charges are independent of time an will not change if the project lasts longer than expected. Costs of general conditions can also be included in other prior change orders. These should be excluded from the cost pool. Other delay costs can include storage fees, winter weather protection and extended insurance costs.
(ii)

Escalation

If the contractor is required to perform in a later period than expected, he may suffer increased labor and material costs. Contract terms limiting escalation may prohibit such a recovery. However, if owner caused delays force a contractor to perform work in a later period of higher wages, the contractor can recover the difference in wages. Furthermore, a time-phase analysis must be done to show the anticipated labor or material costs that should have been expended at the time of the delay and the anticipated hours after the delay to account for any contractor caused problem or delays. These costs are then compared with the actual costs, and the claim would be for the lesser of the two. For example, suppose a contractor planned to spend 100 hours on a job and pay his workers $10.00/hr. The owner causes a delay and during the delay labor rates increased by $2.00/hr. However, at the time of the owner caused delay the contractor had expended less than his planned manpower because of a self-imposed late start which could not be attributable to the owner. A claim for escalation would be calculated as follows: Original Schedule Period 1 60 hours x $10 = Delayed Period 2 40 hours x $12 = $ 600 40 hours x $10 = Actual Labor $400

480 $1,080

60 hours x $12 =

720 $1,120

The claim would be for $80 (the lesser of the actual and planned timephased labor costs). An important tool in calculating escalation is the construction bid and original and modified schedules of manpower and material purchases.

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Again, previous change order work may have been recovered at escalated rates. Previously recovered “escalation” costs should be deleted. Otherwise, this would result in double counting if also included in an overall delay claim.
(iii)

Inefficiency

The same computation of costs would apply. Again, if a previous or separate claim for inefficiency is asserted it should be deleted from a delay claim.
(iv)

Extended Home Office Overhead

Extended home-office overhead is a recoverable item for delays to a project. If a project is delayed it may preclude the contractor from taking on other work to absorb the cost of home office overhead. Therefore, more home office overhead costs should be absorbed by the delayed project. The problem is calculating the cost in a credible way. The formula currently most widely used is the formula first explained in Eichleay Corp., ASBCA §183, 60-2 BCA 2688 (1960). The formula is intended to produce a daily overhead rate of the original contract adjusted to reflect the number of days of actual contract performance. The daily rate is applied to the number of delay days to compute the unabsorbed overhead. It can be calculated as follows: 1. Billings for this contract total billings for this contract period Allocable Overhead Days of Performance Daily Overhead x Total Overhead for Contract Period Daily Contract Overhead Number of Days of Delay = Allocable Overhead

2. 3.

= x

=

Overhead Allocable to Delay

Many courts follow the Eichleay formula in public contracting, but some do not. In fact, this formula has come under attack because (1) there is no proof of causation between delays and damages for extended home office overhead; and (2) there may be no relationship between the overhead damages and actual costs. For example, in Berley Industries. Inc. v. City of New York, 412 N.Y.S.2d 589 (1978), the court rejected the Eichleay formula as mere speculation or conjecture. The court also pointed out that home office involvement normally follows a bell shaped curve during the contract, and therefore the average rate arrived at by the Eichleay formula may overcompensate the contractor for delays near the start or completion of the project, and undercompensate the contractor for delays in the middle of the project. In any event, a contractor should support a claim for home office overhead by showing that the home office was actively involved by devoting time and effort to the project to solve design or engineering problems which caused the delay or disruption. Fehlhaber Corp. v. State, 419 N.Y.S.2d 773 (1979). The contractor should also show that it was not reasonable or feasible for it to obtain
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other work to absorb the overhead during the period of delay. Finally, the pool of overhead costs should be screened to remove costs of other lines of business or non-time related costs which could not possibly be effected by a delay.
5.

Wrongful Termination Claims

The objective of the wrongful termination claim should be to put the contractor in the same position he would have been in if he had been permitted to complete the contracted work. Many contracts, however, place limitations on the types of damage recoverable if a contractor is terminated. Therefore, the appropriate damage amount should reflect the profit that would have been earned by completing the project, any costs associated with the owner’s appropriation of equipment, tools or operating materials, as well as any lost profits from revenues or contracts lost due to the termination. In Action Eng’g. v. Martin Marietta Aluminum, 670 F.2d 456, 460 (3d Cir. 1982), the court ruled that the subjective good faith standard, and not the objective reasonable person standard, should be applied in a situation when the contract allowed the owner to terminate the contractor if “in the owner’s opinion, contractor fails to carry on work diligently and on schedule.” The determination of this should-have-been profit amount is much more complex than a comparison of planned revenues and planned costs. Instead, it involves the projection of the costs that would have been incurred to complete the project, including any inefficiencies or problems encountered. This cost amount can then be subtracted from the agreed upon price for the work (contract amount plus change orders), to yield the true fee that would have been earned had the contract been completed. The calculation should also reflect any mitigating factors or actions undertaken by the contractor. For example, if due to the termination the contractor was free to take on other work it would not otherwise have been able to perform, then the return earned on that work should be subtracted from the lost contract profits calculated above, to produce a measure of damages due to the wrongful termination. Upon termination for default, the owner is usually empowered to withhold progress payments or amounts otherwise owing to the contractor for work performed. If the termination is deemed illegal, the contractor may be entitled to recover the reasonable costs of performing the work, as supported by his job cost records. Termination on a particular project can adversely affect the contractor’s ability to acquire future business. Once again, such claims often have been denied because of lack of the required level of proof regarding substantiation or revenues actually lost. Moreover, linking them directly to the termination can be extremely difficult.
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6.

Quantum Meruit

This section has focused on pricing the most common type of claim: a claim arising from alleged breaches of, or changes to, the construction contract. Such claims compose the overwhelming majority of construction disputes. However, this discussion on claim pricing would not be complete without including a discussion of the quantum meruit claim. The quantum meruit claim is based on the theory that the contractor should be compensated for its work to prevent “unjust enrichment” of the party receiving the benefit of the work. The claim attempts to quantify the increased, unreimbursed value of the project accruing from the contractor’s additional efforts that are caused by the owner. A difference between the quantum meruit claim and a claim related to the “changes” or “extra work” clauses in the contract lies in the rationale for recovery. Where a traditional “changes” claim is based upon the rights conferred by the contract to recover the costs of changes imposed by the owner, the quantum meruit claim is based on an implied right to be reimbursed for work performed. A claim for quantum meruit is inapplicable, however, where the parties have a written or express contract. Roman Mosaic & Tile Co., Inc. v. Vollrath, 226 Pa. Super. 215, 313 A.2d 305 (1973). The claim is usually brought by a subcontractor against an owner with whom the subcontractor does not have a contract, or after termination. These third party claims typically fail. In Kemp v. Majestic Amusement Co., 427 Pa. 429, 234 A.2d 846 (1967), for example, a heating and air conditioning contractor brought an action in quantum meruit against an owner. The contractor had a contract with a tenant which the building owner did not learn of until after the installation. The contractor’s relief was denied. In Meyers Plumbing & Heating Supply Co. v. West End Fed. Sav. & Loan Ass’n., 498 A.2d 966 (Pa. Super. 1985), the court rejected the quantum meruit claim brought by a subcontractor against an owner where the owner had paid the contractor, but the contractor had failed to pay its subcontractor. The court reasoned that having paid for the work once, there was no basis for claiming that the “enrichment’ of the owner was unjust. Id. Similarly, in D.A. Hill Co. v. Clevetrust Realty Invs., 573 A.2d 1005 (Pa. 1990), the court ruled that an unpaid subcontractor could not recover from a lender which had purchased the project from a defaulted owner. The lender was not liable under a theory of quantum meruit because the lender was not enriched, as the value of the property was less than the funds it had advanced to the defaulted owner. Furthermore, even if the lender was enriched by the subcontractor, it was not unjustly enriched because it requested no work for the subcontractor and it did not mislead the subcontractor into performing work. Instead, the subcontractor had waived its lien rights and went forward without the protection of a payment bond. Id.

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If, however, a party contracts with another and accepts the service but without specifying what compensation shall be paid, the party may recover the value of the services under quantum meruit. Martin v. Little, Brown & Co., 304 Pa. Super. 424, 450 A.2d 984 (1981) The measure of damages on a claim of quantum meruit differs from damages available under theories of quasi-contract or unjust enrichment. The measure of damages on a quantum meruit claim is the reasonable value of claimant’s materials and services.
D.

OWNER’ S CLAIMS FOR DEFECTIVE WORK AND DELAYS

Owners may suffer direct damages from the actions of several parties in the construction process. In many instances owners may have recourse against parties for claim amounts owing to contractors. This section will briefly discuss certain parties against whom owners may have cause to seek compensation for damages, the events and actions that can give rise to those damages, and methods of quantifying the claim amounts.
1.

Parties Sued by Owner

The majority of damage claims by owners involve one of three participants (or some combination thereof) in the construction process: contractor/subcontractor, architect/engineer, and construction manager.
a.

Contractors/Subcontractors

Construction contracts set forth the obligations of the contractor to the owner. These obligations revolve around the contractor’s obligation to perform in accordance with the specifications and plans in a specified amount of time. Any deviation in the quality of construction or the scheduled performance period can damage the owner and make the contractor liable to the owner for those damage amounts.
b.

Architectural Firms

The architect performs many functions on a construction project, depending upon his obligations outlined in his contract. These obligations can include design, estimating costs and overseeing the actions of the contractor. Failure to comply with its contract obligations or to otherwise adhere to a minimum standard of practice could lead to compensable damage to the owner.
c.

Construction Manager (CM)

On exceedingly complex or technical projects, e.g., projects with multiple primes or projects utilizing fast tracking or phased scheduling, owners may choose to employ a construction management firm to oversee the coordination and performance of work. The services provided by the construction manager can
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take many forms, ranging from an oversight and guardian function to a guaranteed maximum price for construction agreement, and beyond. As with the architect, if any problems arise in the performance of the construction manager’s services, or in the performance of activities by third parties for which the CM is responsible, he may be liable to the owner for damages suffered by the owner.
d.

Government Officials

Pennsylvania courts have been reluctant to extend liability against township and other governmental officials for their negligent actions. For instance, in both Bendas v. Upper Saucon Twp., 561 A.2d 1290 (Pa. Commw. 1989), and in Schreck v. North Codorus Twp., 559 A.2d 1018 (Pa. Commw. 1989), angry landowners sued township officials for negligence and breach of warranty for the issuance of permits for certain on-site sewage disposal systems. The township’s sewage enforcement officials had conducted tests to determine the suitability of these systems. The systems, however, were determined to be unsuitable once they were installed. The courts dismissed the lawsuits as the townships and their officials were immune from liability, and no implied warranty of merchantability arose from the testing and issuance of permits as these were services and not “goods” under the Uniform Commercial Code. The governing immunity statute is codified at 42 Pa. C.S. § 8451, and contains a number of limited exceptions, which were not implicated in this case.
2.

Actions or Events Giving Rise to Owner Claims

The major events that can generate damages to an owner in relation to a construction project include the following items:
a.

Delay

Delays in project completion can be very costly to the owner in that they deny access to the use of the facility. Delays caused by a contractor can arise from many factors, including inadequate planning or scheduling and poor coordination. As always, the complaining party bears the burden to show that the contractor caused the delay; that it was not an excusable delay; and that the owner’s conduct did not concurrently cause the delay. The owner should also show that any delays it may be responsible for were not critical activities.
b.

Defective or Incomplete Work

Contracts with owners may include provisions where the other party expressly guarantees its work, design or actions. Even in absence of such a clause, the law recognizes an implied warranty on contractor work, holding it to meet certain standards. Any deviation from these specified levels of quality and performance can result in the provision of a substandard facility, unsuitable for the owner’s needs.

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In Elderkin v. Gaster, 447 Pa. 118, 288 A.2d 771 (1972), the Pennsylvania Supreme Court recognized an implied warranty of habitability, as well as an implied warranty of reasonable workmanship, in contracts by builder-vendors selling newly constructed houses. The court reasoned that these implied warranties were necessary to equalize the disparate positions of the buildervendor and the average home purchaser by safeguarding the reasonable expectations of the purchaser compelled to depend upon the builder-vendor’ s greater manufacturing and marketing expertise. Id. See also Tyus v. Resta, 476 A.2d 427, 430-33 (Pa. Super. 1984) (implied warranties apply to newly constructed homes). In Tyus, the court held that an implied warranty of habitability could be limited or disclaimed only by clear and unambiguous language in the parties’ agreement. Language which merely provided that the purchaser inspect the premises before purchase and that he accepted it in its present condition did not amount to a waiver of the implied warranty. The court further ruled that a “reasonable” pre-purchase inspection did not require the buyers to examine the crawlspace below the house. In Groff v. Pete Kingsley Bldg., Inc., 543 A.2d 128, 133 (Pa. Super. 1988), the court extended the concept of implied warranties of habitability and workmanship to a builder who constructed a house on land already owned by the owner/purchaser. The court explained that “[W]e can see no difference between a builder or contractor who undertakes construction of a new home and a builderdeveloper.” Id.
c.

Third Party Claims

In some instances, actions by one party may give rise to a claim against the owner by a third party. For example, if the architect produces defective drawings, which delay the work of the contractor (for time lost during drawing revisions and rework necessary due to the error) and impact his productivity, the contractor may seek to recover those damages from the owner. In such a case, the owner may have recourse to sue the offending party (the architect in the example above) for the amount of the owner’s liability on the third-party claim.
d.

Contract Termination

If the owner terminates a party for default, the owner may suffer damages related to the delays and increased costs associated with having a different party complete the work. Loss of labor learning curve benefits, remobilization costs or other factors can substantially increase the costs to complete the work.
3.

Pricing of Owner’s Damages

In theory, the quantification of claims by the owner is no different than the quantification of contractor claims against the owner. The objective is to quantify the entire incremental cost (actual cost incurred less the should-have-been cost) arising from the disputed action or event. Just as with contractor claims, it is
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essential to link the calculation of damages to the responsible party’s actions, using a cause-effect methodology. The following are some of the more common types of damages claimed by the owner.
a.

Delay Claims: Liquidated Damages

The Owner’s damages for delay can include loss of use and revenue from the facility; increased financing costs; increased costs to other contractors and extra administrative costs. All of these are typically recoverable. The owner’s damages for delay frequently are governed by a liquidated damage provision in the contract. The concept of liquidated damages arose as a method of reimbursing the owner for delay damage where actual damages arising from delay could not be forecast with certainty when the contract was negotiated. As such, liquidated damages are a substitute for the actual damages suffered by the owner, rather than a penalty to the contractor for late completion. Liquidated damages are generally expressed as an amount to be paid per day that the contractor is late completing all or a portion of the work. The court in In re Plywood Co. of Penna., 425 F.2d 151 (3d Cir. 1970), explained that liquidated damages is the sum which a party to a contract agrees to pay as agreed damages if breach occurs. The liquidated damages are good faith estimate of the actual damages that will probably ensue from a breach. A “penalty” is not a pre-estimate of probable damages but is in the form of a punishment designed to prevent a breach. See also Commw., Dept. of Env’t. Resources v. Hartford Accident and Indem. Co., 396 A.2d 885 (Pa. Commw. 1979). In Holt’s Cigar Co. v. 222 Liberty Assocs., 591 A.2d 743 (Pa. Super. 1991), the court struck down a clause as a penalty. The damages clause in the parties’ agreement provided for $500.00/day liquidated damages. The court held that the clause was an unenforceable penalty because the amount was picked arbitrarily and applied even on days that the lessee’s business was not open. The court declined to enforce an agreement which “clearly is not one for true liquidated damages.” See also RESTATEMENT (SECOND) OF CONTRACT § 356(1) (1979). In some states, “[a] term fixing unreasonably large liquidated damages is unenforceable by statute, on grounds of public policy.” See, e.g., Virginia Uniform Commercial Code Section 8.2-718(1). For liquidated damages to be enforceable, it is vitally important that parties to a contract specify when the liquidated damages will start and end. In Sutter Corp. v. Tri-Boro Municipal Auth., 487 A.2d 933 (Pa. Super. 1985), the court addressed the issue of when liquidated damages end under a contract provision assessing $200/day damages for “any work that shall remain uncompleted” after the agreed completion date. Thirteen days after that date the
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project was “substantially complete” and the owner began using the sewage treatment plant. The contractor did not finish all punch-list work until 283.5 days later when the engineer certified final completion. The contractor argued that no liquidated damages should be assessed after issuance of the punch list since the project was substantially complete. The Court disagreed, and held that the contractor was liable for liquidated damages until final completion under the contract terms. Pennsylvania courts can be harsh in enforcing liquidated damages. In Commw. Dept of Transp. v. Interstate Contractor’s Supply Co., 568 A.2d 294 (Pa. Commw. 1990), a contractor was hired to clean and paint 6 bridges. The work was eventually completed after a long period of delay caused by inclement weather. The owner assessed liquidated damages of $200/day. The trial court held the damages unrecoverable as a penalty. On appeal, the court held the liquidated damages were recoverable, even though there was an apparent absence of actual damages and the owner never manifested its displeasure with the work. The court explained that the contract clearly shifted to the contractor the burden of delays not caused by the owner, including the burden of unanticipated happenings such as bad weather. Actual costs of delay are recoverable if liquidated damages are not applicable, or if the contractor abandons the project without completion, even if a liquidated damage clause is present. See J. R. Stevenson Corp. v. Westchester County, 493 N.Y.S.2d 819, 113 A.D. 2d 918 (1985). Actual damages usually includes the costs of the “loss of use” of the facility. Such “loss of use” costs are fact specific and vary from case to case. In addition, the owner may claim excess financing costs, interest and other incremental costs because of the delayed construction.
b.

Pricing the Defective or Incomplete Work Claims

The approach most commonly employed to calculate claims of defective or incomplete work corresponds to the action most frequently followed by owners to remedy the defects: payment to have the faulty work repaired or completed. If performed by the offending party, the corrective work may be performed at no charge to the owner, and all incremental costs associated with the performance of the original defective work and corrections can be backcharged against amounts owing to that party, or pursued through litigation. If performed by a third party, all costs related to execution of the repairs as well as any costs of procuring the new contractor, remobilization, etc., should be aggregated, since they may be sought against the offending party. Fetzer v. Vishneski, 582 A.2d 23, 26 (Pa. Super. 1990) (measure of damages for leaky skylights was the cost to repair or replace). Another approach to measuring damages is the difference in the value of the project as constructed and what the value would have been had it been constructed properly. In Brourman v. Bova, 198 Pa. Super. 279, 182 A.2d 245
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(1962), involving an owner’s claim for failure to perform the contract work in good faith and in a workmanlike manner, the court stated that generally the measure of damages is the difference in value between what is tendered as performance and what is due as performance under the contract, which may consist of the costs to repair. Damages are measured as of the date of the breach. In cases where the cost of repairs is prohibitive or exceeds the diminished value of the facility, measuring damages by the “costs to repair” is not appropriate. In this instance, the accepted measure of damages is the difference between the market value of the building as built and the value had the project been built to contracted specifications. In Freeman v. Maple Point, Inc., 574 A.2d 684, 689 (Pa. Super. 1990). For example, the homeowners purchased a new house for approximately $96,000. Water collected on certain parts of the lot due to an improperly installed driveway, poor grading, and high clay content in the soil. At trial, the homeowners presented testimony that it would cost approximately $50,000 to correct the problem, but presented no evidence as to the diminution in value of the property. The jury awarded only $45,000 in damages. On appeal, the court reversed the award because there was no evidence whether the cost to repair was less than, or greatly exceeded, the diminution in value of the property. The court ruled that “there must be some reasonable basis for determining reduction in value, before a judgment may be made that the costs of repairs is a proper measure of damages, when required repairs to a new house represent a high percentage of the cost of the house.” Id. Another explanation of the measure of damage can be found in Rabe v. Shoenberger Coal Co., 62 A. 854 (Pa. 1906). In Rabe, the Pennsylvania Supreme Court explained that the measure of damages for damage to property is generally the cost of repair where the injury is reparable, unless the cost to repair is equal to or exceeds the diminution value of the property injured. If the injury to the property is permanent, however, the measure of damages becomes the decrease in the fair market value of the property. Id. Examples of non-reparable, permanent injuries when the measure of damages is the diminution in the value of the property include Schlichtkrull v. Mellon-Pollock Oil Co., 152 A. 829 (Pa. 1930) (infusion of salt water to wells due to defendant’s oil well drilling deemed permanent), and Bumbarger v. Walker, 164 A.2d 144 (Pa. Super. 1960) (infiltration of high sulfur content water into a spring due to defendant’s strip mining deemed permanent). Therefore, the rule in Pennsylvania is that the measure of damages where an owner sues for defective construction is the difference in market value of the property as constructed and the market value that the property would have had if constructed as promised, with the qualification that if it is reasonably practical to repair the defects in construction, and if the costs of repairs do not exceed the difference in market value, then the measure of damages in the cost of repairs. Gadbois v. Leb-Co Builders, Inc., 312 Pa. Super. 144, 153, 458 A.2d 555, 557 (1983)
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c.

Pricing the Third Party Liability (Indemnification)

If the owner is sued by a party, and the owner believes that a third party is the real culpable party who may have injured the suing party, the owner may recover amounts by way of indemnification or contribution against the culpable party. The measure of recovery is the amount that the owner was required to pay to the complaining party, to the extent the owner shows that the real culpable party caused or contributed to the complaining party’s damages.
d.

Pricing the Termination Claim

If a contractor or other party is terminated for default, it is most common to find a delay or extension to the project as a result thereof. This results because of the need to determine exactly what work remains to be performed and obtain services from another contractor or firm to finish the work. Pricing the delay claim is the same as in any other case. In addition, the owner can recover the excess costs to complete the work, including costs of loss of labor curve benefits; remobilization; demobilization; interest; financing costs; and, if appropriate, loss of profit. Bloomsburg Mills Inc. v. Sordoni Constr. Co., 401 Pa. 358, 164 A.2d 201 (1960) (measure of damages is the costs to restore the work). If a contractor is terminated for convenience on a federal government project (or some private contracts containing a termination for convenience clause), the contractor should attempt to settle with subcontractors and suppliers and obtain approval of same for the government, and then submit a proposed settlement to the government of all costs incurred as a result of the termination.
E.

OTHER TYPES OF CONSTRUCTION CLAIMS
1.

Mechanic’s Lien Claims

The Pennsylvania Mechanics’ Lien Law of 1963 (hereinafter “Mechanics’ Lien Law” or the “Act”), 49 Pa. Cons. Stat. §1101 et seq., like other state’s lien laws, is designed to protect lower tier contractors by enabling them to bring a claim for payment directly against the owner without requiring the presence of privity between the parties. Although mechanics’ liens statutes are intended primarily for the benefit of parties not in contract with the owner, they may be also be used by parties, such as general contractors and architects, who have contractual arrangements with the property owner. The following is a brief review of mechanic’s lien law.
a.

Creature of Statute

A mechanics’ lien is a statutory claim on real property for the payment of a debt incurred during the course of construction by a property owner, and owed to a contractor, subcontractor, material supplier, architect or engineer. The Pennsylvania statute enables recovery to one who furnishes labor or materials in the erection or construction, alteration or repair of an improvement if the amount Michael R. Libor 26
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of the claim exceeds $500.00. 49 P.S. § 1301. Should payment not occur, the debt may be satisfied ultimately through execution of a mechanics’ lien and distribution of the resulting proceeds from the sale of the secured property through judicial proceedings. The mechanics’ lien is entirely statutory. Since proceedings under a mechanics’ lien are in rem, the law of the state where the property is located controls. See Halowich v. Amminiti, 190 Pa. Super. 314, 315, 154 A.2d 406, 408 (1959). Therefore, although a number of other states have patterned their mechanics’ lien acts after that of Pennsylvania, many have not, including New Jersey and Maryland, whose lien statutes are substantially different in form, theory and practical application. Each state’s statute and cases should be consulted to file liens and perfect lien rights in the respective states. See 53 AmJur 2d (Mechanics’ Liens) § 26.
b.

General Requirements
(i)

Written or Implied Agreement

Although the Mechanics’ Lien Law protects the party who does not have a direct contractual relationship with the property owner, there must be a contract between the owner and general contractor, either written or implied, sufficiently specific in its terms to serve as a foundation for valid mechanics’ lien claims. In order to protect all claims, the contractor should describe in the greatest possible detail the full extent of the work to be done and should incorporate the architectural plans, specifications, and blueprints into any contract with the owner. Prior to commencing work, the subcontractor should examine the prime contract and satisfy himself that its terms are reasonably specific.
(ii)

Compliance with Statute

It is “elementary that a mechanics’ lien is a statutory proceeding, ... and, if the statutory procedure is not complied with, the lien is wholly lost.” Hoffman Lumber Co. v. Mitchell, 170 Pa. Super. 326, 331, 85 A.2d 664, 667 (1952). Because the right to file a mechanics’ lien is a statutory right and in derogation of the common law, the Mechanics’ Lien Law is strictly construed. Despite the courts’ position that claimants under the Mechanics’ Lien Law must strictly adhere to the terms of the Act, the courts often take a more lenient view of pre-lien notice requirements. If notice of the subcontractor’s intention to file a mechanics’ lien claim includes the essential requirements, the courts usually find that substantial compliance has occurred, and the claim is valid. Hazelwood Lumber Co. v. Repoff, 51 Washington Cty. R. 50, 52 (C.P. Washington Co. 1970). However, if no notice is provided, or if essential requirements are omitted, the claim will fail.

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c.

Who May Assert A Lien Claim And Who Is Responsible
(i)

General Contractor

The term “contractor” refers to the original, principal, prime or general contractor; often these terms are used interchangeably. He is the party who contracts with either the owner of the property or with the owner’s authorized agent for the work to be performed; his contract is the “prime contract.” The contract may be either express or implied. The contractor “erects, constructs, alters or repairs an improvement or any part thereof or furnishes labor, skill or superintendence” to a construction project, or “supplies or hauls materials, fixtures, machinery or equipment reasonably necessary for and actually used” in a project, “whether as superintendent, builder or materialman.” 49 P.S. § 1201(4).
(ii)

Subcontractor

The right to lien lies with both the contractor and the subcontractor against the improvement and title or estate of the owner. 49 P.S. § 1301. Generally, the subcontractor enters a contract, either express or implied, with the general contractor to perform a specific portion of the work required under the contract between the general contractor and the owner. As with the general contractor, the subcontractor who “erects, constructs, alters or repairs an improvement or any part thereof; or furnishes labor, skill or superintendence” to a construction project, or “supplies or hauls materials, fixtures, machinery or equipment reasonably necessary for and actually used therein . . . whether as superintendent, builder or materialman,” 49 P.S. § 1201(5), is entitled to a mechanics’ lien.
(iii)

Material Supplier

A material supplier, or materialman, “supplies or hauls materials, fixtures, machinery or equipment reasonably necessary for (a construction project) and actually used therein.” 49 P.S. § 1201(5). A material supplier may assert a mechanics’ lien claim only in his capacity as a general contractor, if he has contracted directly with the owner, 49 P.S. § 1201(4), or in his capacity as a subcontractor, if his contract is directly with the general contractor. 49 P.S. § 1201(5). A party who supplies materials to a subcontractor, e.g., to another material supplier, has no rights under the Mechanics’ Lien Law since the Act explicitly excludes from its coverage any “person who contracts with a subcontractor or with a materialman.” 49 P.S. § 1201(5).

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(iv)

Architects and Engineers

The Mechanics’ Lien Law provides protection to architects and engineers who enter a contract, either express or implied, with the owner; who prepare drawings, specifications and contract documents; and who superintend or supervise the erection, construction, alteration or repair of a construction project. 49 P.S. § 1201(4). However, the Act explicitly excludes from its coverage “an architect or engineer who contracts with a contractor or subcontractor.” 49 P.S. § 1201(5).
(v)

Successor Property Owners

A mechanics’ lien binds the interest of the party named as owner of the property at the time of the prime contract, or acquired subsequently by him. 49 P.S. §1509. In other words, the lien attaches to the improvement and compromises the title of whomever holds it when the lien attaches. The owner’s interest need not be in existence at the time a building is erected; the lien will attach to a title subsequently acquired. Weaver v. Sheeler, 124 Pa. 473, 17 A. 17 (1889). For a claim to be valid, it must be filed against whomever owns the subject property when the claim is made. Edwards v. Stevens, 4 Pa. D.&C.3d 137, 138-39 (C.P. Chester Co. 1977).
(vi)

Lower-tier Subcontractors

Parties who provide materials or services to an improvement pursuant to a contract with a subcontractor are ineligible to assert a mechanics’ lien claim under Pennsylvania law. Hamilton v. Means, 155 Pa. Super. 245, 247, 38 A.2d 528, 529 (1944); 49 P.S. § 1201(5); 49 P.S. §1303(a).
(vii)

Employee of Owner

One who is admittedly an employee of the owner of property, whether a laborer or an individual hired for the purpose of superintending construction on that property, is not a contractor or subcontractor entitled to file a mechanics’ lien claim. Liebow v. Eagle Downs Racing Association, 1 D. & C.3d 671 (C.P. Bucks Co. 1976); 49 P.S. § 1303(a).
(viii)

Contract with Government Entities for Public Projects

Where labor or materials are furnished for a “purely public purpose,” no lien is allowed. 49 P.S. § 1303(b). In other words, where the owner is a governmental body engaged in an activity which may be characterized as governmental, as opposed to proprietary, the mechanics’ lien is unavailable. For example, where a public housing authority contracted for the construction of a low income housing project on its property, the purpose was “purely public.” Empire Excavating Co. v. Luzerne County Housing Authority, 303 Pa. Super. 25, 28, 449 A.2d 60, 61 (1982). Similarly, the construction of a public school has a Michael R. Libor 29
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“purely public purpose.” Visor Builders, Inc. v. Devon E. Tranter, Inc., 470 F. Supp. 911, 919 (M.D. Pa. 1978). Where a governmental entity, in owning and operating a property, acts in a “proprietary and quasi-private” manner, an exception to the general rule that a municipal property is exempt from mechanics’ liens is created, and a mechanics’ lien claim can be brought against such entity. American Seating Co. v. City of Philadelphia, 434 Pa. 370, 375, 256 A.2d 599, 601 (1969). Where the City of Philadelphia acted as an absentee landlord of the property upon which the Spectrum sports arena was built, the arena’s construction was arranged and paid by a private party tenant, and the city, in its capacity as a landlord was engaged in a purely proprietary activity, the Pennsylvania Supreme Court permitted mechanics’ liens claims against the property. Id. The Pennsylvania legislature has provided protection for public works contractors, similar in practical effect to a mechanic’s lien, through the Public Works Contractors’ Bond Law of 1967, 8 P.S. § 191-201.
(ix)

Against Landlord/Owner

Generally, in order to establish the validity of a mechanics’ lien, the person against whom the lien is filed must own the property at the time of the filing of the lien. Edwards v. Stevens, 4 Pa. D. & C.3d 137, 138-39 (C.P. Chester Co. 1977) (citing Weaver v. Sheeler, 124 Pa. 473, 475, 17 A. 17 (1889)). In circumstances, however, where a tenant has contracted for the work to be done to the property, a mechanics’ lien claim against such property and the landlord/owner will be allowed only if the tenant obtains the owner/landlord’s written consent that the improvement to be performed is for the owner’s immediate use and benefit. 49 P.S. § 1303(d). See Murray v. Zemon, 402 Pa. 354, 356, 167 A.2d 253, 254 (1961). The writing may be contained in the lease. Amos v. Clare, 9 Phila. 35 (1872). An owner may be estopped from relying on the writing requirement where fraud or lack of good faith is involved. See Chambers v. Todd Steel Pickling, Inc., 323 Pa. Super. 119, 470 A.2d 159 (1983).
d.

What Items Are Covered
(i)

Labor

The Mechanics’ Lien Law expressly provides that labor may form the basis of a lien against property. 49 P.S. § 1301. Labor “includes the furnishing of skill or superintendence.” 49 P.S. §1201(9). However, the work in question must be done as part of the construction, erection, alteration or repair of a building. See Metropolitan International v. Union Investment Co., 17 Pa. D. & C.3d 519 (C.P. Phila. Co. 1981) the (rejecting mechanics’ lien claim where security guards had provided services during the construction of a building project).
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A lien for labor may be brought by a contractor or subcontractor, 49 P.S. §§ 1201(4), 1201(5), but not by a laborer, Octave v. Beltz, 23 Westmoreland L. J. 218 (1942), nor by an employee of the defendant. Mohler v. Johnston, 63 York Legal Rec. 115, 116 (1949).
(ii)

Materials

Generally, materials furnished for the construction or improvement of a structure are lienable. Materials include “building materials and supplies of all kinds, and also includes fixtures, machinery and equipment reasonably necessary to and incorporated into the improvement.” 49 P.S. § 1201(7). The statute covers materials delivered to the site of construction.
(iii)

Off-Site Improvements

In addition to liens for materials supplied and work performed on-site, liens may be permitted for improvements which are not directly upon the site, but have a physical and beneficial connection to the property. For example, in Morrissey Construction Co. v. Cross Realty Co., 42 Pa. D. & C.2d 533 (C.P. York Co. 1966), the construction of a driveway on a lot, sidewalk, curb, storm and sanitary sewer and street appurtenant to the lot, which was necessary for the ordinary and usual purpose of the property, formed the basis of a valid claim. Id. at 537. See also Grimes v. Barnes, 85 Montgomery Cty. L. Rep. 305, 306 (C.P. Montgomery Co. 1965) (construction of a trench was the proper subject of a mechanics’ lien claim). Similarly, mechanics’ liens have been allowed, in other jurisdictions, against property for pipes laid in the street for water or gas mains or for sewers; against a pumping plant for piping laid in the streets and connected therewith; and against a refrigerating plant for pipes laid in the streets to supply vapor for cold storage to remote customers. See 53 AmJur 2d (Mechanics’ Liens) § 85.
(iv)

Materials Stored Off-Site

In Kissinger Structural Sales, supra, where materials were specially manufactured for a project but never delivered to the site, the failure to deliver rendered the materials unlienable.
(v)

Incomplete Work

Whether incomplete work is covered by the Act turns, at least in part, upon the circumstances under which work is interrupted. The Act provides: Except in case of destruction by fire or other casualty, where, through no fault of the claimant, the improvement is not completed, the right to lien shall nevertheless exist. 49 P.S. § 1305. The progress made by the claimant prior to the cessation of the project may also be important; although courts do not require completion of an
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improvement for recovery, the courts may insist upon evidence that the property was in fact improved in some manner. Courts have held that, where the claimant’s efforts have not improved the value of the property, there is no right to a lien. Dagit v. Radnor Convalescent and Nursing Home. Inc., 38 Pa. D. & C.2d 389, 392 (C.P. Delaware Co. 1965).
(vi)

Rental Equipment and Temporary Works

The Act does not address whether rental equipment and temporary works may form the basis of a claim. The statute at least suggests that under certain circumstances, such materials may be lienable: No lien shall be allowed for that portion of a debt representing the contract price of any materials against which the claimant holds or has claimed a security interest under the Pennsylvania Uniform Commercial Code or to which he has reserved title or the right to reacquire title. 49 P.S. § 1303(e) (emphasis added). Furthermore, the statute defines materials as those supplies and fixtures “reasonably necessary to and incorporated into the improvement.” 49 P.S. § 1201(7) (emphasis added). Where materials are used in construction but then retained by the claimant, (e.g., scaffolding), the statute suggests that no lien may be placed against those materials. However, 49 P.S. § 1303(e) and 1201(7) should be read in conjunction with 49 P.S. § 1201(4) and 1201(5) where contractor are defined. Both contractor and subcontractor are defined to include those who supply or haul materials, fixtures, machinery or equipment reasonably necessary for and actually used therein. Read together, these provisions suggest that where materials or equipment are used in construction by a claimant who retains title in the materials or equipment during and after construction, his claim will be rejected, since title was retained by him and the materials were not incorporated into the improvement. However, where the claimant rents equipment reasonably necessary for and actually used in a project, his costs may be the subject of a claim.
(vii)

Overhead

Office overhead, insurance, taxes and profits are not, by themselves, lienable. However, if these expenses are included in the total contract price, or where they constitute part of the reasonable value of labor furnished, they may be lienable.

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e.

Protection for Owner Against Claims
(i)

Waiver of Lien

A waiver is the voluntary and intentional relinquishment of a known right, privilege or claim. Often the central issue in disputes about waivers is the intention, either express or implied, of the parties involved. While the waiver is clearly advantageous to the owner, at the same time it involves a compromise on the part of the contractor. Courts insist that this compromise be made knowingly. The mechanics’ lien is a statutory privilege which may be waived by agreement of the parties. Courts presume that every contractor, subcontractor and material supplier desires the security provided by the Mechanics’ Lien Act. Therefore, the burden is upon the owner to prove that the waiver agreement existed and was set forth in clear, unequivocal terms. A contractor or subcontractor may waive his right to a mechanics’ lien by a written instrument signed by him, or by any conduct or implied promise so clearly evidencing the intent to waive that the contractor or subcontractor cannot fail to understand the consequences of his conduct. A provision in a contract barring liens is valid in the absence of fraud, bad faith or misleading conduct. Shadie Electrical v. Highland Manor Assoc., 41 Pa. D. & C.3d 633, 635-36 (C.P. Luzerne Co., 1983). The waiver is invalid where the owner and contractor are the same person, and the owner files a waiver agreement asserting that the waiver by the contractor constitutes a waiver by all subcontractors as well. Id. at 635. In the prime contract or by separate agreement, the contractor may create a waiver of claim that will be binding on all subcontractors. 49 P.S. § 1402. To assert a waiver agreement against a subcontractor, there must be proof that actual notice was provided to him before he furnished labor or materials, or proof that the contract or separate written instrument was filed in the office of the prothonotary in the county where the work is performed. The filing must occur either prior to commencement of work, or within ten days after the execution of the prime contract, or not less than ten days prior to the contract with the subcontractor. The waiver must be indexed in the owner’s name as plaintiff and the contractor’s name as defendant, and also in the contractor’s name as plaintiff and the owner’s name as defendant. 49 P.S. § 1402. It is the owner’s duty to ensure that the stipulation to waive the right to file a mechanics’ lien claim is properly filed and indexed; failure will invalidate the waiver against the subcontractor. See Site Improvements. Inc. v. Central & Western Chester County Industrial Development Authority, 293 Pa. Super. 1, 437 A.2d 960 (1981).

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(ii)

Owner May Retain Funds Due to Contractor

An owner who has been served with a notice of intention to file or a notice of the filing of a claim by a subcontractor may retain out of the funds due or to become due the contractor a sum sufficient to protect the owner from loss until such time that the claim is finally settled, released, defeated or discharged. 49 P.S. § 1601. In so doing, the owner avoids paying twice for the same work, and may prevent the perfection of the mechanics’ lien against his property.
(iii)

Owner May Pay Claim of Subcontractor

Should the contractor fail to settle, discharge, defend or secure against the mechanics’ lien claim, the owner may pay the subcontractor’s claim. Upon making this payment, “the owner shall be subrogated to the rights of the subcontractor against the contractor together with any instrument or other collateral security held by the subcontractor for the payment.” 49 P.S. §1604(1).
(iv)

Owner May Defend Against Claim

Where the contractor fails to settle, discharge, defend or secure against the claim, the owner may undertake a defense against the claim. If the owner elects to defend, the contractor is liable to the owner for all costs incurred in the defense, including reasonable attorneys’ fees, regardless of whether the owner’s defense is successful. 49 P.S. § 1604(2).
(v)

Owner May Post Bond

As will be explained more fully in the discussion of bonds, the owner may arrange for a surety to post a bond to insure the owner’s payment to all concerned parties upon the completion of the improvement.
(vi)

Owner May Limit Claims to Unpaid Balance

Where there is no waiver of liens, and the subcontractors’ claims in the aggregate exceed the unpaid balance of the contract price specified in the primary contract between the owner and contractor, the owner may limit the claims of the subcontractors to a pro-rata share of the unpaid balance of the contract price. Before having furnished labor or materials, the subcontractor must have actual notice of the total contract price and its payment provisions, or the contract must have been filed with the prothonotary in the manner described in 49 P.S. § 1402 (procedure for filing of stipulation to waive right to mechanics’ lien). The owner must request an order of the court to limit liability to the unpaid contract price.

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(vii)

Notice to Contractor of Claim

An owner who is served with a notice of intention to file claim may give written notice of such to the contractor. If the owner retains funds due to the contractor, he must give such notice to the contractor. 49 P.S. § 1602(a).
(viii)

Contractor’s Duties on Receipt of Notice

When the contractor receives notice as described above, within thirty days from receipt the contractor must do one of the following:
(a)

Settle or Discharge Claim

Settle or discharge the claim of the subcontractor and furnish the owner with a written copy of a waiver, release or satisfaction, signed by the claimant, 49 P.S. § 1603(1); or
(b)

Defend Against Claim

Agree in writing to undertake to defend against said claim, and if the owner has not retained sufficient funds to protect against loss, furnish the owner additional approved security to protect the owner from loss in the event the defense should be abandoned by the contractor or should not prevail, 49 P.S. §1603(2); or
(c)

Provide Security to Owner

Furnish to the owner approved security in an amount sufficient to protect the owner from loss on account of said claim. 49 P.S. §1603(3)
2.

Bond Claims

The use of surety bonds on construction projects serves to shift and spread certain risks faced by owners, contractors and suppliers. The primary risks are that the general contractor will either prove unable to complete a project, or will fail to pay all of its subcontractors or suppliers. While subcontractors and suppliers usually have some degree of protection against non-payment from their right to file mechanics’ liens against the property, the owner may be left at the mercy of the general contractor and may suffer from an encumbered title where the general contractor fails to meet its obligations to subcontractors and suppliers. Additionally, subcontractors and suppliers with lien rights still face a difficult process of foreclosure, and run the risk that the encumbered equity will not suffice to pay their claim. Moreover, these lien protections are generally unavailable on government construction projects, since most governmental entities are insulated by statutory immunity to lien claims. The intent of this section is to discuss the type and form of claims that may be brought against surety bonds.
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a.

Types of Bonds

Bid, performance and payment bonds are the three basic surety agreements in the construction industry. These instruments come in a variety of forms. Generally, the purpose of a bid bond is to assure the owner (the obligee) that the successful bidder will enter into a contract and meet all precontractual requirements. For sake of brevity, bid loads will not be covered here. The payment bond functions as assurance to the owner that the contractor’s obligations to subcontractors, suppliers, and laborers will be satisfied so as not to constitute a charge to owner. The performance bond obligates the surety to fulfill the terms of the contractor’s contract so that the owner receives the project it bargained for. In private projects, the parties negotiate the terms of bonds. As to public works, the scope of responsibility under these instruments is set by the legislative enactments of the federal and state governments and political subdivisions. Under Pennsylvania law, surety contracts (bonds) must be in writing. Tudor Development Group. Inc. v. U.S.F. & G, 692 F. Supp. 461, 463 (M.D. Pa. 1988) (oral agreement to answer for the debt of another is unenforceable). See also 33 P.S. § 3 (Purdon 1967) (agreement to answer for default of another must be in writing).
b.

Payment Bonds on Non-Public Projects

The terms of payment bonds on private projects may vary widely. The claimant on a payment bond must examine the bond itself to determine the scope of his rights. The payment bond is a guarantee by the surety to the obligee (usually the owner) that the contractor (principal) will pay the claims of those persons who furnish labor and materials to the owner’s construction project, thereby avoiding liens against the property. The payment bond also provides assurance to subcontractors and material suppliers that their legitimate bills will be paid.
(i)

Persons Protected by Payment Bonds

Unlike federal and state projects where statutes determine who is covered by the payment bond, on private project, the language of the bond instrument itself determines who is protected. Parties are free to negotiate the extent of protection, and such bonds may cover sub-subcontractors if the bond so provides. Potential claimants should obtain a copy of the payment bond to ascertain their rights. Should litigation ensue and a question as to the claimant’s status arises, helpful precedents can be found in cases interpreting statutes governing payment
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bonds for federal projects known as the “Miller Act” and, on state projects, the “Little Miller Act,” which are discussed later. Typically, however, payment bonds protect all persons who provide labor, materials, equipment and machinery, or render services in the prosecution of work, directly to the contractor or to a subcontractor of the contractor. As explained more fully in the sections on the Miller Act and the Little Miller Act regarding public projects, a person providing labor or material to a supplier (rather than a subcontractor) of a contractor or a subcontractor is typically not a permitted claimant under payment bonds. The crucial distinctions between a supplier and a subcontractor are explored in the sections regarding the Miller and Little Miller Act. Unpaid claimants can bring a direct action against the principal and the surety.
(ii)

Defenses to Claims Against the Bond

Where the subcontractor or supplier brings a claim against the payment bond, the surety stands in the shoes of the principal contractor. Exton Drive-In. Inc. v. Home Indemnity Co., 436 Pa. 480, 261 A.2d 319 (1969), cert. denied, 400 U.S. 819 (1970) (contractor was not liable for delay on the project and, therefore, his surety was not liable to the owner). As with the bid and performance bond, the surety may assert all defenses available to the contractor. In Toth v. Connelly, 116 P.L.J. 237 (1967), a subcontractor could not recover on a payment bond for delay damages caused by weather conditions because the contractor did not cause the delay and weather conditions constituted a force majeure. See also East Crossroads Center Inc. v. Mellon Stuart Co., 112 P.L.J. 162, aff’d, 416 Pa. 229 (1969) (surety not liable where obligee breached construction contract). The surety may also defend on the grounds that the claimant did not give proper notice or otherwise did not comply with conditions precedent as set forth in the payment bond. Other defenses which may be asserted by the surety include payment by the principal to the claimant, Siata International U.S.A.. Inc. v. Insurance Company of North America, 362 F. Supp. 1355, rev’d, 498 F.2d 817 (3d Cir. 1974), or settlement of the claims.
(iii)

Notice Requirements

Most payment bonds contain strict notice requirements which are conditions precedent to the surety’s liability on the bond. A claimant who fails to comply with such requirements does so at his peril. Woodling v. U.S.F. & G., 15 Northumb. L.J. 354 (1942). As with notice requirements, time periods within which a suit may be brought are usually set forth in the bond instrument. The surety may waive the defense that the claimant filed an untimely action, as was the case in Travelers Indemnity Co. v. Rexnord. Inc., 389 A.2d 246 (Pa. Commw. 1978), where the surety consented to extension of the payment schedule.
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(iv)

Rights and Options of the Parties

The payment bond was executed to protect the interests of subcontractors and suppliers where the prime contractor fails to pay. It further protects the owner from liens against the property due to claims by unpaid subcontractors and suppliers by providing a source of funds. When a contractor does not meet its obligations to subcontractors and suppliers, the surety has three options: pay the claim, defend the claim, or force the contractor to either defend or pay the claim. The prime contractor has the right to insist that the claimant demonstrate the validity of its claim, and may negotiate a compromise where possible. The prime contractor may choose to lie back and allow the surety to fight his battle; however this is not the wisest course since the prime contractor is ultimately liable for any successful claim, either directly or through its indemnification agreement to its surety. Sureties are liable on payment bonds to materialmen regardless of payment by the owner to the principal on the bond. National Casualty Co. v. Ferry, 56 Dauph. 369 (1945). Sureties, however, are not liable to the obligee for breach of a contractual duty of good faith and fair dealing or punitive damages under the Unfair Insurance Practices Act, 40 P.S. S 1171, et seq., (which provides that the Pennsylvania insurance department can maintain actions for violations of the Act), and which provides sufficient deterrence against bad faith conduct. Tudor Development Group. Inc. v. U.S.F. & G., 692 F. Supp. 461, 465 (M.D. Pa. 1988). There are generally two claims asserted by an unpaid claimant. First, the claimant may be able to sue both the party with whom it has contracted and the surety for breach of the construction contract on the bond if the bond incorporates the general contract which required that the contractor/principal pay for all labor and materials on the project. This is because both versions of the AIA Payment Bonds incorporate the Contract (which typically requires that the contractor pay for materials and supplies on the Project), and the surety and the contractor expressly state in the bond that they bind themselves “jointly and severally” to pay for such labor and materials pursuant to the Contract Second, the principal and surety are liable “on the bond” because the bond creates an independent source of liability to the benefit of claimants.
c.

Payment Bonds on Federal Projects: Miller Act Bonds

The great majority of federal works bonds are governed by the Miller Act, 40 U.S.C. §§ 270a-270f (1982), which pertains to any contract for the construction, alteration or repair of any public building or public work of the United States the value of which exceeds $25,000.00. To encourage private parties to contract with the federal government, and to alleviate the harshness that
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would otherwise result from the unavailability of mechanics’ liens, Congress requires prime contractors to procure payment bonds for the protection of subcontractors and material suppliers. The Miller Act also requires performance bonds for the protection of the government. Performance bonds provide no protection to subcontractors or suppliers. See Morrison Assurance Co. v. United States, 3 Cl. Ct. 626, 632 (1983). The discussion which follows focuses upon payment bonds, since the payment bond is the source of most litigation arising out of public contracts. The Miller Act payment bond protects persons who have furnished “labor or materials in the prosecution of the work . . . who [have] not been paid in full . . . sums justly due.” 40 U.S.C. § 270b(a).
(i)

Parties Protected by the Miller Act Bond

The Miller Act provides that the payment bond is for the protection of individuals who supply material or labor for use in the prosecution of the prime contract and who have not been paid in full. The Miller Act defines “person” to include any individual, partnership, corporation or other legal entity. While the Act’s express language suggests that its scope is broad, the Act’s coverage extends only to those parties who supply labor or material directly to the prime contractor, and to those who supply labor or material directly to a subcontractor (rather than a supplier) of the prime contractor. Consequently, a third-tier subcontractor or a person who supplies to a supplier of the prime contractor has no protection under the Miller Act.
(a)

First Tier Subcontractor

On the first tier, there is no need to distinguish between subcontractors and suppliers who deal with the prime contractor directly, although this is a critical distinction for entities below the first tier.
(b)

Second Tier-Sub-subcontractors and Suppliers

A sub-subcontractor, like an ordinary materialman of a subcontractor, may avail himself of the protection of a payment bond by giving the required statutory notice, but those in more remote positions may not. The necessity of a contractual relationship between the prime contractor and the first-tier subcontractor cannot be overemphasized where the issue is the protection afforded to second-tier parties. The distinction is critical because suppliers and subcontractors of a subcontractor of the prime contractor are covered by the Miller Act, while suppliers and subcontractors of a first-tier supplier are not protected. Therefore, persons contracting with other parties who provide services directly to the prime contractor should inquire as to whether that party is a subcontractor or supplier of the prime contractor.
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The distinction between subcontractors and suppliers is often difficult to make, and there is no hard and fast rule applied by the courts. Instead, courts consider a number of factors, focusing on the substance of dealings between the prime contractor and the party through whom the plaintiff claims. These factors include the manner in which the party through whom the plaintiff claims is characterized by the prime contractor, i.e., does the prime contractor refer to him as a subcontractor or as a supplier, United States ex rel. Gulfport Piping Co. v. Monaco & Son. Inc., 336 F.2d 636 (4th Cir. 1964); the timing of payments, e.g., payments on an invoice basis suggest that the party is a supplier, while progress payments suggest that the party is a subcontractor; whether the party performs services or provides material to the prime contractor which are required under the prime contract, United States ex. rel. Gibson v. Leon Perlin Co., Inc., 680 F.2d 340 (4th Cir. 1982); United States ex rel. Parker-Hannif in Corp. v. Lane Construction Corp., 477 F. Supp. 400 (M.D. Pa. 1979); the role played by the party in coordinating activity on the job; and whether the party was required by the prime contractor to obtain a payment bond. Courts generally define a supplier as one who supplies fungible goods which are part of his general inventory and the production of which does not require a specialized or customized manufacturing process in order to meet specifications, regardless of the cost of the materials.
(c)

Employees

The Miller Act protects certain classes of employees on federal construction projects. Whether an employee is covered by the payment bond turns on the status of his employer. In United States ex rel. Sherman v. Carter, 353 U.S. 210 (1957), the Supreme Court ruled that employees of a prime contractor were protected as first-tier suppliers of labor on a construction project. However, in J.W. Bateson Co. Inc. v. United States ex rel. Board of Trustees, 434 U.S. 586 (1978), the Court refused to extend protection to a sub-subcontractor’s employees because they lacked either an express or implied contractual relationship with the prime contractor or one of its subcontractors. By implication, it would follow that employees of subcontractors fall within the scope of the Act, although no cases precisely on point have been identified.
(d)

Exceptions to the Third Tier Exclusion Rule

The rule that third tier parties are beyond the coverage of the Miller Act payment bond has several limited exceptions which require close scrutiny of the particular facts of each case. A third tier subcontractor may receive Miller Act protection where a first or second tier subcontractor has become insolvent, and the former second or third tier subcontractor has thereafter dealt directly with the first tier subcontractor. The insolvency and new dealings may elevate the status of prior second or third tier subcontractors. Another exception exists where a first tier subcontractor is a wholly owned subsidiary of the prime contractor, and a
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court may be persuaded to view the prime and the first tier subcontractor as a single entity if the subsidiary is merely a sham corporation. In such case, the subcontractor who contracts with the prime contractor’s subsidiary may be characterized as a first tier subcontractor, and the status of other subcontractors is elevated accordingly.
(ii)

Failure to Provide Miller Act Bonds

The Miller Act performance bond only protects the government; failure to provide this bond affects no other party. This is not the case with payment bonds; failure to require or provide payment bonds may seriously jeopardize the interests of subcontractors and material suppliers. In Appeal of R.T. Madden Co., ASBCA No. 22999, 81-2 BCA § 15,312 (1981), it was held that a contract is formed despite the failure to obtain Miller Act bonds, and subcontractors and suppliers are left with few practical remedies where a prime contractor fails to make required payments. Generally, there no liability on the part of the United States for failure to require Miller Act bonds. In 4 Star Construction Corp. v. United States, 6 Cl. Ct. 271, 273 (1984), a subcontractor’s suit against the government for failure to require a Miller Act payment bond was dismissed, since the Act does not create a right to sue the government for compensation owed by the prime contractor. Miller Act claimants may, however, have an equitable lien on funds retained by the government under the prime contract. See Aetna Casualty and Surety Co. v. United States, 526 F.2d 1127, 1130 (Ct. Cl. 1975), cert. denied, 425 U.S. 973 (1976). Resort to this equitable remedy against those funds is extremely limited and has been permitted only in situations where the claimant showed that the surety on the Miller Act payment bond was insolvent. United States ex rel. Reuter v. McDonald Construction Co., 295 F. Supp. 1363, 1366 (E.D. Mo. 1968). Federal courts will generally limit a Miller Act surety’s liability to the express terms of the bond it provides. Therefore, where no payment bond exists and a performance bond does not include guarantees other than completion of the project, there is no liability of the surety to unpaid subcontractors and suppliers. Babcock & Wilcox Co. v. American Surety Co., 236 F. 340, 342-43 (8th Cir. 1916).
(iii)

Scope of Miller Act Coverage
(a)

Labor and Materials

The Miller Act allows recovery for “labor or material.” Most items can be readily identified as such, but the scope of this provision has been the subject of many lawsuits. What, for example, is the status of rented equipment, purchased equipment, equipment repairs, items supplied for but diverted from use in the bonded project, delay damages, attorneys’ fees and lost profits?
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(b)

Delay Damages

The question of the recoverability of delay damages is unsettled. Some authority holds that delay damages are not recoverable (see, e.g., McDaniel v. Ashton-Mardian Co., 357 F.2d 511 (9th Cir. 1966); Lite Air Products. Inc. v. Fidelity & Deposit Co. of Md., 437 F. Supp. 801, 803 (E.D. Pa. 1977)), but other courts have reached the opposite conclusion where the subcontract specifically provided for such recovery, and in one instance on public policy grounds alone. In United States ex rel. Mariana v. Piracci Construction Co.. Inc., 405 F. Supp. 904 (D.D.C. 1975), the subcontractor sought recovery of damages for delay, asserting that the delay increased his materials cost due to purchase at a later time, increased labor cost for the same reason, increased labor cost attributable to inefficiencies, increased overhead due to extended performance time and indirect costs. Similarly, the U.S. Courts of Appeals for the Fifth and Eleventh Circuits have also held that a claimant may receive delay damages from a Miller Act payment surety. See United States v. Co-Real Support Group. Inc., 950 F.2d 284 (5th Cir. 1992); United States v. Harvesters Group.. Inc., 918 F.2d 915 (11th Cir. 1990).
(c)

Attorneys’ Fees, Finance Charges and Lost Profits

Unlike the law regarding delay damages, the law regarding recovery of attorneys’ fees, finance charges and lost profits is well settled: they are not recoverable. Knecht Inc. v. United Pacific Ins. Co., 860 F.2d 74 (3d Cir. 1988) (attorney’s fees not recoverable on a payment bond as a sum “justly due”); Reliance Universal Ins. Co. v. Ernest Renda Const. Co., 454 A.2d 39 (Pa. Super. 1982) (service/finance charges not recoverable); Arthur N. Olive Co. Inc. v. United States ex rel. Marino, 297 F.2d 70, 72 (1st Cir. 1961); Lite Air Products. Inc. v. F. & D. Ins. Co., 437 F. Supp. 801, 804 (E.D. Pa. 1977).
(iv)

Statute of Limitations

The Miller Act states that: no such suit shall be commenced after the expiration of one year after the day on which the last of the labor was performed or material was supplied by him.... 40 U.S.C. § 270b(b). The Pennsylvania Supreme Court has recently ruled that suit must be filed on a payment bond within one year and ninety (90) days from last performing work. Centre Concrete Co. v. AGI. Inc., 559 A.2d 516 (Pa. 1989). The court explained that under the Pennsylvania Public Works Contractors’ Bond Law, a Michael R. Libor 42
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claimant may not bring an action on the bond unless he remains unpaid 90 days after last performing work or supplying material. Therefore, the claimant’s “cause of action” does not accrue until after that 90 day period of time. Additionally, the claimant must provide notice within ninety days of completion of the work of his intention to file a claim. 40 U.S.C. § 270(b). Failure to provide timely notice results in forfeiture of the claim; courts have no discretion to waive the notice requirement. Id.
(v)

Defenses to Claims Against the Miller Act Payment Bond

The surety and prime contractor can defend an action brought against a Miller Act payment bond by asserting that all of the Act’s technical requirements have not been met. The defendant may challenge the claimant’s standing. For example, in an action brought by a second tier subcontractor, the prime contractor may assert that the first tier party was a supplier rather than a subcontractor so that the claimant is not covered by the Act. The defendant may assert that materials provided by the claimant were not used on the project and that no reasonable belief existed that they would be used. The defendant might also challenge the adequacy of notice. In an interesting decision, the Florida Supreme Court in American Gas. Co. v. Coastal Caisson Drill Co., 542 So.2d 957 (Fla. 1989), ruled that a contractor could not waive its rights under a public payment bond as against public policy. This issue apparently has not been decided by the Pennsylvania courts, although some federal decisions appear to permit a party to waive its rights under a payment bond. See United States v. James McHugh Sons, 21 F. Supp. 202 (D. Okl. 1938), aff’d, 108 F.2d 55 (5th Cir. 1938). A charge, claim or setoff which a prime contractor has against a Miller Act subcontractor claimant may also be asserted as a defense to a Miller Act claim. However, a general contractor cannot raise a setoff defense against a claimant with whom he does not have privity of contract. United States v. Avanti Constr., Inc., 750 F.2d 759 (9th Cir.), cert. denied, 106 S. Ct. 60 (1984).
d.

Payment Bonds on Public Projects in Pennsylvania: “Little Miller Act” Bonds

Each state has enacted its own version of the Miller Act to provide subcontractors and suppliers with protection comparable to what they would receive on private projects through mechanics’ lien law. The Public Works Contractors Bond Law of 1967, 8 P.S. § 191, et seq. (Pennsylvania’s “Little Miller Act”), so closely parallels its federal counterpart that courts interpret this statute by applying Miller Act case law. As with the Miller Act, the single most important factor in determining whether Pennsylvania’s Little Miller Act applies is whether the Commonwealth Michael R. Libor 43
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or one of its agencies, departments, political sub-divisions or other state instrumentalities is a party to the prime contract, and whether the project at issue involves construction of a structure or public work. Pennsylvania’s Little Miller Act definition of which contracting bodies fall within its purview is very broad. For instance, any city, county, school district, state-aided institution, borough, political subdivision or township falls within the requirements of the Little Miller Act. Pennsylvania, bonds are required on all projects the value of which exceeds $5,000.00. 8 P.S. § 191(3) (a). Another key factor is whether the project involves the expenditure of public funds, either directly or indirectly. In Southwest Alloy Supply Co. v. Pennsylvania Power & Light Co., 66 D&C2d 3 (Northampton Co. 1974), it was held that the Little Miller Act did not apply to a construction project where a public utility was the owner, since the utility was a private corporation and did not receive public monies. Pennsylvania’s Little Miller Act provides protection to parties coextensive with the coverage of the Miller Act, i.e., first tier subcontractors and suppliers, and second tier subcontractors and suppliers where the party with whom the second tier contracts is a subcontractor and not a supplier. Pennsylvania follows the Supreme Court’s definition of a subcontractor as “one who performs for and takes from the prime contractor a specific part of the labor or material requirements of the original contract. Clifford F. MacEvoy Co. v. United States, 322 U.S. 102, 109 (1944).
e.

Performance Bonds on Public Projects (State and Federal)

The performance bond is provided to protect the obligee (owner) from losses arising from the principal’s (contractor’s) failure to complete performance. Performance bonds are commonly required on both public and private projects. On public projects, both the Miller and Little Miller acts require the posting of a performance bond by the general contractor. The Miller Act provides that the performance bond shall be “. . .In an amount as [the contracting officer] shall deem adequate for the protection of the United States.” 40 U.S.C.A. § 270a(1). The Little Miller Act requires a bond “. . at one hundred percent of the contract amount. . . .” 8 P.S. § l93(a)(1). Since little case law on performance bonds has developed outside of public works projects, issues relating to such bonds on public and private projects are addressed together herein. See Lite-Air Products v. Fidelity & Deposit Ins. Co. of Maryland, 437 F. Supp. 801 (M.D. Pa. 1977) (where language of bond is similar to that of Little Miller Act, cases interpreting the requirements under the Miller Act determine the scope of liability under the bond).
(i)

Persons Protected by Performance Bonds

The owner is the named obligee in the bond and is the party primarily protected by the contractor’s performance bond. The Little Miller Act provides
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that the performance bond “. . . shall be solely for the protection of the contracting body which awarded the contract.” 8 P.S. § l93(a)(1). Sometimes, however, the project lender may also be named as the co-obligee.
(ii)

Scope of Bond Coverage

In the event of a default by the principal, the surety will be called upon to either complete the project, or pay damages to finance the completion of the project. The surety’s obligation is limited to the penal sum of the bond. As work progresses on the project and the contractor is paid, those progress payments reduce the penal sum of the bond. Direct and consequential damages may be recovered on the performance bond. Direct damages are those sustained by the owner as a direct result of the contractor’s failure to perform, and typically consist of the lesser of the cost to complete the project, or the difference between the market value of the project as contemplated by the contract and the market value of the project as built, including defective work. Consequential damages are those that indirectly result from the contractor’s default, and under basic contract law are recoverable only if the parties could have reasonably foreseen such damages as likely to result from a default at the time the contract was executed. Consequential damages may include additional fees and loss of opportunity or loss of use of the facility. The prevailing view is that a surety is liable for delay damages resulting from a project being completed behind schedule, including liquidated damages. Riva Ridge Apts. v. Robert G. Fischer Co. Inc., 745 P.2d 1034 (Colo. App. 1987). The owner must assert these claims prior to releasing final payment as, once final payment has been made, the owner loses the right to recover liquidated damages from the performance surety. County of Dauphin v. Fid. & Dep. Ins. Co. of Maryland, 770 F. Supp. 248 (M.D. Pa. 1991). A surety may also be liable for the cost of replacing work which is defective and in breach of contract warranty or guaranty. Tudor Development Group, Inc. v. U.S.F. & G., 692 F. Supp. 461, 463 (M.D. Pa. 1988); see C&B Construction Co. v. Nashville School Dist., 484 S.W.2d 519 (Ark. 1972) (defective roof on school).
(iii)

Defenses to Claims Against the Bond

The surety may assert any defense available to the principal under the contract. In addition, the surety may raise any defense arising either by virtue of the terms of the bond or the conduct of the obligee or principal. See Houston Fire & Cas. Ins. Co. v. E.E. Cloer General Contractor, 217 F.2d 906 (5th Cir. 1954) (where surety steps into the shoes of the contractor upon default, it is entitled to all the benefits owed the contractor, but it also assumes all the contractor’s liabilities). Michael R. Libor 45
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Generally, the surety’s liability for defaults of its principal is no greater than the liability of the principal. Similarly, the surety may not raise defenses that the principal is barred from asserting. The surety may, however, assert the defense that the obligee failed to perform a condition precedent in the bond. See, e.g., AIA Performance Bond G312; Provident Trust Company of Philadelphia v. Metropolitan Cas. Ins. Co., 152 F.2d 875 (2d Cir.), cert. denied, 327 U.S. 789 (1946) (surety not liable where obligee/owner failed to advance promised sums to the principal in breach of contract). If the bond expressly provides that the liability of the surety is conditioned upon proper notice, a court may find, as did Pennsylvania’s Supreme Court in Barati v. M.S.I. Corp., 243 A.2d 170, 172-74 (Pa. 1965), that the surety can impose reasonable conditions before it may be held liable on the performance bond. The requirement of the Miller Act that public contractors obtain a payment and performance bond places no affirmative duty on the government to ensure that the bonds have in fact been obtained, and thus, there is no liability of the government should the contractor fail to obtain the bonds. Arvanis v. Moslo Eng. Consultants. Inc., 739 F.2d 1287 (8th Cir. 1984), cert. denied, 469 U.S. 1191 (1985). Another defense which may be raised by the surety is the running of the statute of limitations. The statute of limitations on a performance bond is one year from the accrual of the cause of action. See 42 Pa. C.S.A. § 5523. In Turner Constr. Co. v. American States Ins. Co., 579 A.2d 915, 919 (Pa. Super. 1990), the court ruled that a cause of action on a performance bond accrued on the date that the subcontractor declared its unwillingness to remedy its sidewalk settlement problem, and not on the date that the contractor became aware of the problem. Although the surety does have a number of defenses available to it in respect to claims against the performance bond, a surety should be cautious in rejecting demands made under the performance bond. When such demands are rejected, the obligee proceeds to complete performance and the surety loses substantially all control over the cost of completion, exposes itself to claims for consequential damages and risks the possibility that claims may be made for bad faith and improper conduct. Consequently, there are defenses to liability on the bond, the surety is well advised to take immediate legal action through declaratory judgment seeking an order that the surety has either no liability or limited liability under the bond. Such an approach has the advantage of putting the surety on the offensive and permits the selection of the most favorable forum in which the obligee may be sued.
(iv)

Events Triggering Surety Liability

The surety has no obligations under the performance bond until the contractor is declared by the owner to be in default, except that the surety in some circumstances must attend conferences called by the owner when the owner is considering declaring a contractor in default. See AIA Document A3l2
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Performance Bond (1997 ed.). The contract or the bond instrument will usually define a contractor’s default. See AIA Document A3l2 Performance Bond (1997 ed.). Examples include failure to timely prosecute the work, performing defective work, abandonment of the project, failure to pay subcontractors or suppliers, and contractor’ s bankruptcy. Generally, there is no default where the contractor ceases work due to circumstances beyond his control, such as weather, an unforeseen strike, an unjust refusal of the owner to make payments, or because the owner refuses to permit reasonable adjustments to accommodate significant changes.
(v)

Rights and Options of the Prime Contractor

Upon being notified that he may be in default on a performance bond, the prime contractor has three options: (1) he may deny the default and request appropriate relief, (2) he may cure the default and complete the project, or (3) he may admit default and cooperate with the surety to minimize damages. Only in extreme circumstances should the contractor abandon the job and expect to avoid liability.
3.

STATUTORY CLAIMS – UNFAIR TRADE PRACTICES AND CONSUMER PROTECTION LAWS
a.

Statutory Consumer Protection Claims

In the construction context, owners and consumers, particularly in the residential market, can bring claims under the state Uniform Deceptive Trade Practices Act (“UDTPA”), the Unlawful Trade Practices Act, the False Advertising Act and the Consumer Fraud Act. In Pennsylvania, these independent statutes are collected under the Unfair Trade Practices and Consumer Protection Law (“UTPCPL”), 73 P.S. §§ 201-1 et seq. The breadth of the causes of action provided for by state legislatures is often surprising both to defendants and claimants who, until recently, have not widely utilized these causes of action in the construction context. A defendant violates the UDTPA or UTPCPL when it knowingly makes false and misleading statements of fact concerning the nature, characteristics and quality of its product or services in its sales brochures, advertising materials, and at sales and marketing events. The Pennsylvania UTPCPL provides in pertinent part: A person engages in a deceptive trade practice when, in the course of business, vocation, or occupation, the person: ****
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(v).

represents that the goods or services have . . . characteristics, . . . uses, benefits or qualities that they do not have. . . . **** represents that goods or services are of a particular standard, quality, or grade . . . if they are of another.

(vii).

73 P.S. § 201-2.
b.

Types of Claims

Pennsylvania’s UTPCPL provides a private right of action to enforce the provisions of the statute. This right of action is not limited to a specific segment of the public; instead, a UTPCPL claim may be brought by any person likely to be damaged by a deceptive trade practice. 73 P.S. § 201-9.2. Two common types of claims include (1) misrepresentation claims against a manufacturer of a product, a component in a larger assembly or a completed building and (2) claims by an owner that a contractor or manufacturer made misrepresentations. In Pennsylvania, plaintiffs must overcome three hurdles. First, they must establish that the transactions at issue are “trade” or “commerce” within the meaning of the law. Second, plaintiffs must show that the law grants a private cause of action for the appurtenant injuries. Finally, plaintiffs must show that the act complained of is unfair or deceptive. See In re Zishotlz, 226 B.R. 824 (Bankr. E.D. Pa. 1998). Some states’ UDTPA provide for an affirmative injunction against ongoing unfair and deceptive practices that are likely to damage consumers. Courts may issue an affirmative, or mandatory injunction, which “require[s] the defendants to do an affirmative act. . . .” Central Trust Co. of New York v. Moran, 56 Minn. 188, 195, 57 N.W. 471, 473 (1894). See also 73 P.S. § 201-4. Moreover, in some states there is no distinction in the eyes of the law between affirmative and preventive injunctions. The injunctive relief provided under the UDTPA and the UTPCPL generally is in addition to remedies otherwise available against the same conduct under the common law or other statutes of the state. See Com. by Zimmerman v. National Apartment Leasing Co., 519 A.2d 1050 (Pa. Commw. 1986).
c.

Standing to Bring Claims

Consumers—and in some instances owners and contractors—may bring claims under three basic consumer protection statutes: the Unfair Trade Practices Act, the False Advertising Act and the Consumer Fraud Act. These acts, and similar acts such as the Pennsylvania UTPCPL, reflect a clear legislative policy encouraging aggressive prosecution of statutory violations and thus should be liberally to effect its purpose of preventing unfair or deceptive practices. Com. by
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Creamer v. Monumental Properties, Inc., 329 A.2d 812 (Pa. 1974); Com. by Zimmerman v. Bell Tel. Co., 551 A.2d 602 (Pa. Commw. 1988).
(i)

Protection of statutes may be available to contractors and suppliers

The Minnesota Supreme Court recently answered two significant questions regarding its consumer protection statutes: (1) who may bring a claim; and (2) what is the nature of the pleading and proof that is necessary to such a claim. Group Health Plan, Inc. v. Philip Morris Inc., 621 N.W. 2, 5 (Minn. 2001). These decisions may predict a trend in case law in other states under their various state consumer protection statutes. In Group Health, the Supreme Court rejected the argument that the remedies provided for in these statutes are intended only for consumers – that is, purchasers and users of the product that are the subject of an alleged misrepresentation. In finding that the plaintiffs, a group of HMOs and sophisticated merchants of health care services, had standing to assert claims under these consumer protection statues, the Supreme Court in Group Health first looked to the language of the Unfair Trade Practice Act, the False Advertising Act and the Consumer Fraud Act. The Court noted that these statutes broadly authorize “any person” to sue for alleged violations. Group Health, 621 N.W.2d at 6 (emphasis added). The Court also noted that “[n]either the private remedies statute nor the substantive statutes contains any language restricting those who may sue to purchasers or consumers.” Id. at 8. Finally, the Court concluded that because the Legislature had not indicated in any way that it did not intend for this broad interpretation, the HMOs should be permitted to proceed with their claims. Id. at 11. The Supreme Court’s decision in Group Health, together with the Court’s earlier decisions in Humphrey v. Philip Morris, Inc., 551 N.W.2d 490 (Minn. 1996) and Minh Ly v. Nystrom, 615 N.W.2d 302 (Minn. 2000) (en banc), indicate that these statutes are available to commercial and sophisticated consumers such as owner and contractors, as well as ordinary citizens, under certain limited circumstances. See also Chalfin v. Beverly Enterprises, Inc., 741 F.Supp. 1162 (E.D. Pa. 1989) (corporate operator of a nursing home was a “person” within the meaning of the act). A producer, who is not in the retail business of reselling a product, but is in the business of designing, manufacturing and selling building systems containing that product, like the plaintiffs in Minh Ly, (Group Health and Humphrey), arguably is a consumer of that product for the purposes of the consumer protection statutes.

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(ii)

“Merchants” may be limited to remedies provided by the UCC

In defense of a UDTPA claims by a commercial entity, a defendant may argue that such an entity is a “merchant” in goods of the kind, whose remedies are limited to those provided by the Uniform Commercial Code (“UCC”). As in the Minh Ly case, it can be argued that a fabricator is a consumer of the component product, not a “merchant in goods of the kind.” Some courts have strictly construed the phrase “merchant in goods of the kind” when determining whether a plaintiff is entitled to remedies in addition to those provided by the UCC. See, e.g., Jennie-O Foods, Inc. v. Safe-Glo Prod. Corp., 582 N.W.2d 576 (Minn. Ct. App. 1998) (corporation that purchases heaters for use in commercial turkey farms not a “merchant” of these heaters; permitted to assert claims in tort). To the extent that a producer of construction assembly is a merchant, it is a merchant in the business of designing, manufacturing, selling and/or constructing these building systems. Therefore, that entity arguably is entitled to assert statutory claims, as well as its warranty and contract claims, against the manufacturers of the component.
4. TORT ACTIONS a.

Strict Products Liability Claims

In the construction context, strict products liability claims can arise when a building product or assembly fails to perform as expected, causing injury or damage to a contracting party, a third party, or the project itself. To recover under Pennsylvania law for a strict products liability claim, a plaintiff must establish that the product was defective, that the defect was the proximate cause of the injury to the plaintiff, and that the defect which caused the injury existed at the time that the product left the seller’s possession. Davis v. Berwind Corp., 547 Pa. 260, 267, 690 A.2d 186, 190 (1997). Because a construction product rarely passes directly from the manufacturer to the construction site, but instead is handled, fabricated and often incorporated into larger assemblies by other parties, all parties within the supply chain may be subject to this type of claim. At the same time, each of the parties in the chain may assert as a defense that the actions or inactions of the other parties in the supply chain caused the complained-of defect or injury. In at least one case, a federal district court sitting in Pennsylvania ruled that a design-build engineering concern could be sued by an owner under a strict liability theory. See Abdul-Warith v. Arthur G. McKee & Co., 488 F. Supp. 306, 310 n.3 (E.D. Pa. 1980). As with many tort claims, a claim grounded in a strict products liability theory may be subject to limitation under the economic loss doctrine. See East River S.S. Corp. v. Transamerica Delaval, Inc., 476 U.S. 858, 871 (1986) (purely economic losses are not recoverable in negligence and strict liability tort actions Michael R. Libor 50
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in the absence of personal injury or damage to property other than the product itself).
b.

Negligence Claims Against Contractors and Other Parties

Claimants often contend that another party involved in the project was negligent and that such negligence was a legal cause of damage sustained by claimant. In order to prevail on this negligence claim, a claimant must prove, as in all negligence actions, that: 1) defendant owed a duty of care to plaintiff; 2) that the defendant was negligent; and 3) defendant’s negligence was a legal cause of damage sustained by plaintiff. Negligence claims are often asserted in addition to, or in lieu of, breach of contract claims because negligence claims may permit recovery of punitive or exemplary damages and avoid contractual limitations on the amount or type of recoverable damages. Courts in some jurisdictions hold that the existence of a contractual relationship generally excludes the opportunity to present purely economic harms as tort claims. See Wolfe v. Continental Cas. Co., 647 F.2d 705 (6th Cir. 1981), cert. denied, 454 U.S. 1053, (1981) (under Ohio law, when the essence of a claim is to seek recovery for the value of a contract, the action is for breach of contract rather than negligence); Berschauer/Phillips Constr. Co. v. Seattle Sch. Dist. No. 1, 124 Wash. 2d 816, 881 P.2d 986 (1994) (purely economic loss is remediable only in contract claim). Other jurisdictions hold that the negligent performance of a contractual duty can support a negligence action. See St. Paul Ins. Co. v. Estate of Venute, 275 Ill. App. 3d 432, 656 N.E.2d 113 (1995), appeal denied, 165 Ill. 2d 565, 662 N.E.2d 431 (1996) (contractor owed Owner duty of care when performing renovation work that resulted in flooding of Owner’s medical building); Langner v. Charles A. Binger, Inc., 503 So. 2d 1362 (Fla. Dist. Ct. App. 1987) (negligent performance of a contract may support actions in both tort and contract). A third line of reasoning focuses on whether the duty breached is imposed by agreement of the parties (breach of contract) or whether it is imposed by operation of law regardless of the agreement or non-agreement of the parties (tort). See Sam Finley, Inc. v. Barnes, 156 Ga. App. 802, 275 S.E.2d 380 (1980) (Owner has right to maintain an action in tort if the contractor violates a duty owed to owner, independent of the contract, to avoid harming owner). Consequently, in some jurisdictions a Contractor may be liable to an Owner both in tort and contract if the Owner can establish that there is an independent duty of care owed by the Contractor to the Owner. However, most jurisdictions require contractual privity prior to imposing tort liability for purely economic loss. See Danforth v. Acorn Structures, Inc., 608 A.2d 1194 (Del. 1992) (economic loss doctrine precluded buyer of building kit for home from recovering from seller); Council of Co-owners Atlantis Condominium, Inc. v. Whiting-Turner Contracting Co., 308 Md. 18, 517 A.2d 336 (1986) (developer and builder liable to homeowner’s association for negligent construction of building); Floor Craft Floor Covering, Inc. v. Parma Comm. Gen.
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Hosp. Ass’n, 54 Ohio St. 3d 1, 560 N.E.2d 206, 209 (1990) (no cause of action for economic damages against design professionals who drafted plans and specifications, in the absence of privity of contract); Spivack v. Berks Ridge Corp., 402 Pa. Super. 73, 586 A.2d 402 (1990) (economic losses may not be recovered in tort absent physical injury or property damage).
c.

Intentional Misrepresentation (Fraud)

Fraud is a false representation of fact, whether by words, conduct or concealment, which misleads and is intended to mislead another so that the recipient relies on the false representation to its injury. To recover on a fraud claim against the defendant, a plaintiff must prove by clear and convincing evidence that: 1) the other party knowingly concealed facts which it had a duty to disclose; 2) the concealment of facts was material to the transaction; 3) the concealment of facts was made with the intent of misleading plaintiff; 4) plaintiff was justified in relying on the concealment, and did, in fact, so rely; 5) plaintiff was injured; and 6) the injury was proximately caused by its reliance on the defendant’s concealment. In order to recover, the knowing concealment must be material; that is, it must be important to, or have influence on, the transaction at issue. In the construction context, a fraud claim requires reasonable reliance on a material fact knowingly or recklessly represented or concealed by another with an intent to deceive. See Gary v. E. Frank Miller Constr. Co., 208 Ga. App. 73, 430 S.E.2d 182 (1993) (fraud not actionable unless buyers of home can prove that contractor knowingly made false statements and that buyers reasonably relied on such statements).
d.

Negligent Misrepresentation

Some courts have ruled that some negligent misrepresentations may give rise to a claim for damages. This cause of action generally arises out of Section 552 of the Restatement (Second) of Torts, which provides: Information Negligently Supplied for the Guidance of Others. (1) One who, in the course of his business, profession, or employment, or in any other transaction in which he has a pecuniary interest, supplies false information for the guidance of others in their business transactions, is subject to liability for pecuniary loss caused by them by their justifiable reliance upon the information, if he fails to exercise reasonable care or competence in obtaining or communicating the information. (2) Except as stated in Subsection (3), the liability stated in Subsection (1) is limited to loss suffered
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(a) by the person or one of a limited group of persons for whose benefit and guidance he intends to supply the information or knows that the recipient intends to supply it; and (b) through reliance upon it in a transaction that he intends the information to influence or knows that the recipient so intends or in a substantially similar transaction.
e.

Negligence Claims Against Professionals

Construction litigation often involves a negligence suit against a design professional -- an architect or an engineer -- working on the construction project. A contractor or other participant not in privity with the designer may try to bring a negligence suit against an architect for defective plans or specifications, an engineer for faulty inspection, or against other professionals for negligent performance during the construction project. An architect is negligent if he or she fails to exercise a degree of care consistent with superior knowledge and skill when acting in a professional capacity. See, e.g., First Nat’l Bank v. Cann, 503 F. Supp. 419 (N.D. Ohio 1980), aff’d, 669 F.2d 415 (6th Cir. 1982) (architect does not guarantee a perfect result, but must meet the prevailing standard of care); Donnell & Froom v. Baldwin County Bd. of Educ., 599 So. 2d 1158 (Ala. 1992) (standard of care for architect is that exercised by a reasonably prudent architect under similar circumstances). A court may also impose upon the architect or design professional a common-law duty to disclose to the Owner the consequences of errors in design or construction that are obvious or well known within the profession. See, e.g., Comptroller of Virginia v. King, 232 S.E.2d 895 (Va. 1977). The economic loss doctrine may come into play in cases where claims are brought by parties not in contractual privity with the alleged negligent design professional. In a series of recent cases, however, some courts have begun to counter this rule. In Carolina Casualty v. 60 Gregory Blvd., __ A.2d __, 2000 Conn. Super. LEXIS 739 (Conn. Super. Ct. 2000), for example, the court held that privity of contract was not necessary for a surety to recover for its economic damages suffered by its principal, a contractor, caused by an architect’s negligence in failing to provide adequate documents and to properly administer the project. This case runs counter to the growing tendency of courts to apply the economic loss rule to shield architects, engineers and even contractors who provide services. A considerable number of courts, including a federal district court applying Pennsylvania law, still hold fast to the rule that economic losses are not recoverable against parties not in contractual privity. The Supreme Court of Washington, for example, declined to recognize an exception to the economic loss
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rule for negligence actions against an architect, structural engineer, and project inspector in Berschauer/Phillips Constr. v. Seattle Sch. Dist. No. 1, 124 Wash. 2d 816, 881 P.2d 986 (1994). There, the plaintiff contractor suffered economic damages for delays on a project for renovation and new construction work at a school. The plaintiff alleged inaccurate and incomplete architectural and structural engineering plans, as well as negligence for failing to competently inspect. Finding that there is a “beneficial effect to society when contractual agreements are enforced and expectancy interests are not frustrated,” the court held that in construction disputes, the contracts entered into among the various parties should govern their economic expectations. Id. at 828. See also Hartford Fire Ins. Co. v. Associated Construction and Mgmt. Corp., __ F. Supp.2d __, 2000 U.S. Dist. LEXIS 4959 (E.D. Pa. 2000) (no economic loss recovery against engineer retained by design-builder); Calloway v. City of Reno, 993 P.2d 1259 (Nev. 1999) (no economic loss recovery against contractor).
f.

Limitations on Non-Contractual Actions: The Economic Loss Doctrine

Situations often arise where a product or assembly on a construction project malfunctions or fails to perform as intended. Negligence or products liability claims are often asserted against both the manufacturer of the product and the builder who was contractually bound either to construct the project or to purchase and install the defective product. A contract-based action is also usually included since the failure to perform as agreed or intended is the essence of a breach of contract or warranty claim. As construction litigation continues to grow and courts wrestle with the tort/contract distinction, it is important to understand the scope and breadth of the economic loss doctrine as a defense to tort actions. The application of the doctrine has significant consequences in construction litigation. For instance, restricting claims to contract-based causes of action potentially limits the parties who are directly responsible to the plaintiff for the alleged damages. It may also restrict the parties’ claims and defenses to their contractual rights and remedies, significantly limit the types of damages recoverable, and may even leave the plaintiff without any remedy at all. See, e.g., Commercial Union Ins. Co. v. Kirby Bldg. Sys., Inc., Nos. 97-7272, 97-7285, aff’d without opinion, 149 F.3d 1163 (3d Cir. 1999) (plaintiff’s tort claims were precluded by the economic loss doctrine, and contract-based claims were barred by the Uniform Commercial Code’s statute of limitations). Furthermore, different substantive and procedural rules apply in tort and contract claims, including application of the Uniform Commercial Code and different statutes of limitations. All of these issues may impact the ultimate outcome of the litigation. The economic loss doctrine provides that purely economic losses are not recoverable in negligence and strict liability tort actions in the absence of personal injury or damage to property other than the product itself. See East River S.S. Corp. v. Transamerica Delaval, Inc., 476 U.S. 858, 871 (1986). Since East River,
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the economic loss doctrine has been adopted in a majority of jurisdictions. See id. at 868. The primary rationale for the economic loss doctrine is that principles of tort law are not intended to compensate commercial parties for losses suffered as a result of breach of contract duties. Contract principles, such as warranty, on the other hand, are well suited for commercial controversies because the parties can set the terms of their agreements and, within limits, disclaim warranties or limit remedies while allowing the purchaser to obtain the benefit of the bargain. These policy rationales are particularly applicable to construction claims. Construction projects are characterized by detailed and comprehensive written contracts that define the parties’ rights and responsibilities. The contracting parties are usually free to adjust their respective obligations to satisfy their expectations. A buyer can also often address or avoid economic loss problems from construction defects by obtaining insurance, negotiating a warranty, or by reducing the contract price to reflect the risk of any hidden defects.
(a)

What Constitutes “Economic Loss?”

Economic losses not recoverable in tort have generally been defined as “damages for inadequate value, costs of repair and replacement of the defective product, or consequent loss of profits--without any claim of personal injury or damage to other property.” Economic loss also covers “the diminution in the value of the product because it is inferior in quality and does not work for the general purposes for which it was manufactured and sold.” In the construction context, such economic loss damages may include the cost of repair and replacement of defectively designed or constructed items, consequential damages due to delay, lost profits or loss of value due to deterioration of a defectively designed or constructed item.
(b)

The “Product Itself” vs. “Other Property” Distinction

A majority of jurisdictions have adopted East River and find that damage that a product causes to itself to be economic loss, unrecoverable in tort, while damages to “other property” are recoverable in tort. While adhering to the “product itself” vs. “other property” distinction, courts have differed on the interpretation of these terms. In 2-J Corp. v. Tice, 126 F.3d 539 (3d Cir. 1997), the Third Circuit Court of Appeals, applying Pennsylvania law, held that inventory and other items being stored in a warehouse at the time of its collapse was “other property,” damage to which was recoverable in tort. The court stated that for the purposes of the economic loss doctrine, the product is no more and no less than whatever the manufacturer placed in the stream of commerce by selling it to the initial user. 55

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When a manufacturer places an item in the stream of commerce by selling it to an Initial User, that item is the product itself. . . . Items added to the product by the Initial User are therefore other property, and the Initial User’s sale of the product to a Subsequent User does not change these characterizations. Id. at 543. In Metropolitan Prop. and Cas. Ins. Co. v. James McHugh Constr. Co., 1999 WL 971283, at *3 (N.D. Ill. 1999).the court reaffirmed Illinois’ “other property” exception to the economic loss doctrine, finding that where a home was flooded by an allegedly faulty sprinkler system, the economic loss rule prevented the plaintiff from recovering in tort for damage done to the home. Personal belongings in the home, however, constituted “other property,” damage to which was recoverable in tort.
(c)

Application of the Doctrine to Contracts Involving Services

Most courts apply the economic loss doctrine in equal force to service contracts in the construction industry. In Commercial Union v. Kirby, Nos. 977272, 97-7285 aff’d without opinion, 149 F.3d 1163 (3d Cir. 1999), the Third Circuit Court of Appeals ruled that under Pennsylvania law, the economic loss doctrine applies to claims involving the provision of services as it does to product liability claims. There, the plaintiff claimed negligent design and engineering services with respect to the design, sale and erection of a pre-engineered building. The court recognized that the principal cases applying the economic loss doctrine generally involved actions based on products liability, but found that a host of courts applying Pennsylvania law have employed the economic loss doctrine in actions having nothing at all to do with products.
F.

CONTRACTUAL LIMITATIONS ON LIABILITY

Construction contracts typically contain many exculpatory clauses by which a party is relieved of either liability or damages for certain actions. Under Pennsylvania law, limitation of liability clauses and other exculpatory provisions in contracts between sophisticated parties of equal bargaining strength generally are enforced. See Valhal Corp. v. Sullivan Associates, 44 F.3d 195, 202-04 (3d Cir. 1995). There are, however, exceptions to the general rule. A leading case regarding contract provision limiting damages, Kalisch-Jarcho, Inc. v. City of

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New York, 58 N.Y.2d 377, 448 N.E.2d 413 (N.Y. 1983), stated the exception as follows: ...[A]n exculpatory agreement, no matter how flat and unqualified its terms, will not exonerate a party from liability under all circumstances. Under announced public policy, it will not apply to exemption of willful or grossly negligent acts. *** More pointedly, an exculpatory clause is unenforceable when, in contravention of acceptable notions of morality, the misconduct for which it would grant immunity smacks of intentional wrongdoing. This can be explicit, as when it is fraudulent, malicious, or prompted by ... bad faith. Or, when, as in gross negligence, it betokens a reckless indifference to the rights of others, it may be implicit. *** In either event, the policy which condemns such conduct is so firm that even when ... it is determined *** that the conduct sought to be exculpated was within the contemplation of the parties, it will be unenforceable. Id., 58 N.Y.2d at 384-385 (citations omitted; emphasis added). See also Georgetown Steel v. Union Carbide Corp., 806 F. Supp. 74 (D.S.C. 1992), remanded, 1993 WL 358770 (4th Cir. 1993) (exculpatory clauses generally disfavored and strictly construed). Some states have statutes which further circumscribe the inforcement of exculpatory provisions. See, e.g., N.Y. Gen. Oblig. Law §§ 5-322.1 and 5-323 (McKinney’s 1999) (clauses exempting a party from "liability for injuries to person or property" caused by his ordinary negligence in a contract for work performed or services rendered in connection with the construction of real property or its appurtenances is void and unenforceable as a matter of public policy.)
1.

“No Damages for Delay” Clauses

One of the most common exculpatory clauses is the “no-damages-fordelay” clause, which relieves the Owner from paying damages for delays on the Project. Indeed clauses such as these can even be found in multiple prime situations where the Owner attempts to relieve itself not only of delay damages but also from coordinating multiple prime contracts. Broadway Maint. Corp. v. Rutgers, 447 A.2d 906 (N.J. 1982). Exculpatory clauses are enforceable unless the claimant can show parties did not contemplate the situation at the time the contract was executed. See Coatesville Contractors & Eng.. Inc. v. Ridley Park, 509 Pa. 553, 506 A.2d 862 (1986) (clause not enforceable because Owner breached express promise that the lake bed would be dry for the Contractor’s work); Gasparini Excavating Co. v. Pennsylvania Turnpike Com., 409 Pa. 465, 187 A.2d 157 (1963) (lack of complete access to work site due to operations of third parties not with contemplation of the parties); Commonwealth Dept. of Highways v. S.J. Groves and Sons Co., 20 Pa. Commw. 526, 343 A.2d 72 (1975) (lack of access to the work site for causes not within the contemplation of the Contractor). But see John B. Gregory & Son, Inc. v. A. Guenther & Sons Co.,
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147 Wis.2d 298, 432 N.W.2d 584 (1988) (refusing to recognize uncontemplated delays exception to enforceability of no-damages-for-delay clause). However, a delay that is “reasonably anticipated from the circumstances attending the project” will not invalidate a limitation of damages provisions. Henry Shenk Co. v. Erie County, 319 Pa. 100, 104, 178 A. 662, 664 (1935). See also P.T. & L. Constr. Co. v. Dept. of Transp., 108 N.J. 539, 531 A.2d 1330 (1987). Exculpatory provisions such as a “no-damages-for-delay” clause may also be waived by the Owner. In Findlen v. Winshendon Housing Auth., 28 Mass. App. Ct. 977, 553 N.E.2d 554 (1990), a Massachusetts court ruled that an Owner waived a no-damages-for-delay clause by paying one delay claim and indicating a willingness to consider others.
2.

Pay When Paid Clauses

A “pay-when-paid” clause provides that a prior payment from a thirdparty is a condition precedent to a Contractor’s payment to its subcontractor so that the contracting parties share the credit risk of the source from which the funds will come. To the extent the clauses are not well drafted, courts are not inclined to enforce them. Instead, courts hold that they fix a time period for payment and that after a reasonable time period the money must be paid, despite the language in the clause. See Schuler-Haas Elec. Corp. v. Aetna Cas. & Sur. Co., 371 N.Y.S.2d 207 (App. Div. 4th Dept. 1975) (language in contract did not set a condition precedent); United Plate Glass Co. v. Metal Trim Indus.. Inc., 525 A.2d 468 (Pa. Commw. Ct. 1987) (clause not enforced because it was not a “condition precedent”); but see Crown Plastering v. Elite Assoc., 560 N.Y.S.2d 694 (App. Div. 2nd Dept. 1990) (clause enforced because payment was a “condition precedent”). In order to be enforceable, a pay-when-paid clause should be drafted to provide expressly that (1) payment from the owner is a condition precedent, (2) that the parties share the credit risk, and (3) that the subcontractor agrees that it is to be paid only from a specific fund from the owner. State statutes governing “prompt payment” may govern payment terms on contracts, and trump conflicting contract provisions. See, e.g., Pennsylvania Contractor and Subcontractor Payment Act, 73 P.S. §§ 501-516 (Purdon 2001); Md. State Fin. & Proc. Code Ann. Section 15-101 through 105 (Repl. Vol. 1995 and 1997 Supp.).

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