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V.

OVERVIEW OF POTENTIAL CONSTRUCTION CLAIMS


AND DAMAGES ..................................................................................... 1
A.

Claims Under the Contract............................................................. 1

B.

Other Types of Claims ................................................................... 1

C.

CONTRACTORS CLAIMS FOR DIRECT COSTS,


PROJECT OVERHEAD AND IMPACT COSTS........................ 1

D.

E.

F.

1.

Formal and Constructive Changes ..................................... 2

2.

Inefficiency and Disruption Claims ................................... 8

3.

Acceleration Claims ......................................................... 11

4.

Delay and Schedule Extensions Claims........................... 13

5.

Wrongful Termination Claims ......................................... 18

6.

Quantum Meruit ............................................................... 19

OWNER S CLAIMS FOR DEFECTIVE WORK AND


DELAYS ...................................................................................... 20
1.

Parties Sued by Owner ..................................................... 20

2.

Actions or Events Giving Rise to Owner Claims............. 21

3.

Pricing of Owners Damages ........................................... 22

OTHER TYPES OF CONSTRUCTION CLAIMS ..................... 26


1.

Mechanics Lien Claims................................................... 26

2.

Bond Claims..................................................................... 35

3.

STATUTORY CLAIMS UNFAIR TRADE


PRACTICES AND CONSUMER PROTECTION
LAWS............................................................................... 47

4.

TORT ACTIONS............................................................. 50

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


1.

No Damages for Delay Clauses.................................... 57

2.

Pay When Paid Clauses.................................................... 58

Michael R. Libor
Morgan, Lewis & Bockius LLP

V.

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 Owners 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.

CONTRACTORS 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

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Disruption Claims

Acceleration

Delay and Extension Claims

Termination Claims

Quantum Meruit

1.

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 contractors 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.

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.

Michael R. Libor
Morgan, Lewis & Bockius LLP

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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Morgan, Lewis & Bockius LLP

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 OBrien & Gere
Engr., 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


partys 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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Morgan, Lewis & Bockius LLP

when the Commonwealth failed to provide site access. The court awarded
damages for the delay, plus it affirmed the Board of Arbitrations 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 Courts 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 owners 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 contractors 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.
Michael R. Libor
Morgan, Lewis & Bockius LLP

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 attorneys 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 attorneys 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 arbitrators
award against an owner who refused to pay. The court found that the owners 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.
Michael R. Libor
Morgan, Lewis & Bockius LLP

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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Morgan, Lewis & Bockius LLP

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.
Michael R. Libor
Morgan, Lewis & Bockius LLP

10

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
owners 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 contractors 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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Morgan, Lewis & Bockius LLP

11

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 contractors 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
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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 =

Actual Labor

$ 600

40 hours x $10 =

$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.
Inefficiency

(iii)

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.
Extended Home Office Overhead

(iv)

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.

2.
3.

Billings for this contract


total billings for this
contract period
Allocable Overhead Days
of Performance
Daily Overhead

Total Overhead for


Contract Period

Daily Contract
Overhead
Number of Days of
Delay

Allocable Overhead

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 owners appropriation of
equipment, tools or operating materials, as well as any lost profits from revenues
or contracts lost due to the termination. In Action Engg. 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 owners 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 contractors
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 contractors 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 contractors relief was denied. In Meyers Plumbing & Heating
Supply Co. v. West End Fed. Sav. & Loan Assn., 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
claimants 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 contractors 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 managers
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 townships 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
owners 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 owners 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 owners 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 Owners 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 partys 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 Owners 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 owners 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 Envt.
Resources v. Hartford Accident and Indem. Co., 396 A.2d 885 (Pa. Commw.
1979).
In Holts 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 lessees 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 Contractors 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 owners 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 defendants 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 defendants 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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Morgan, Lewis & Bockius LLP

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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 partys 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.

Mechanics 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 states 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 mechanics 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
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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 states 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 subcontractors 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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Morgan, Lewis & Bockius LLP

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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 owners 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 owners
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
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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 arenas 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 mechanics 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/landlords
written consent that the improvement to be performed is for the owners
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
claimants 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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Morgan, Lewis & Bockius LLP

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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 owners name as plaintiff and
the contractors name as defendant, and also in the contractors name as plaintiff
and the owners name as defendant. 49 P.S. 1402. It is the owners 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 subcontractors 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 owners 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 owners 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)

Contractors 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
contractors 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
contractors 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 owners 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 claimants 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, affd, 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, revd, 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 suretys 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
Acts express language suggests that its scope is broad, the Acts 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-subcontractors
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 contractors 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 subcontractors 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 suretys 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)
(attorneys 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
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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 claimants
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 Acts technical requirements
have not been met. The defendant may challenge the claimants 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), affd, 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. (Pennsylvanias 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 Pennsylvanias Little Miller Act applies is whether the Commonwealth
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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.
Pennsylvanias 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.
Pennsylvanias 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 Courts 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 principals (contractors) 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 contractors 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 suretys 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
contractors 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
contractors 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 contractors
liabilities).
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Generally, the suretys 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
Pennsylvanias 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 contractors 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).

(vii).

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.

73 P.S. 201-2.
b.

Types of Claims

Pennsylvanias 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

Consumersand in some instances owners and contractorsmay 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 Courts decision in Group Health, together with the Courts
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 sellers 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
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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) defendants 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
Owners 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 homeowners association for negligent
construction of building); Floor Craft Floor Covering, Inc. v. Parma Comm. Gen.
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Hosp. Assn, 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
defendants 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 Natl Bank v. Cann, 503 F. Supp. 419 (N.D. Ohio 1980),
affd, 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 architects
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,
affd without opinion, 149 F.3d 1163 (3d Cir. 1999) (plaintiffs tort claims were
precluded by the economic loss doctrine, and contract-based claims were barred
by the Uniform Commercial Codes 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.
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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 Users 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 affd 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 (McKinneys 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 Contractors
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 Contractors 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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