The Critical Path: Tools for Resolving Construction Disputes : California Construction Lawyer & Attorney for Dispute Resolution in Los Angeles, San Diego & the S.F. Bay Area

Barriers to conflict resolution are many, and much has been written about them. In Insightful or Wishful: Lawyer’s Ability to Predict Case Outcomes, a legal studies research paper for the new law school at the University of California at Irvine, noted American psychologist Elizabeth Loftus addresses another barrier to settlement that we lawyers are loath to admit: overconfidence. Indeed, the “saber rattling” of mediation colloquy can sound like the dramatic dialogue out of a Star Wars movie:

Luke: Soon I’ll be dead and you with me. Translated: We’re spending a boatload of money litigating this case but you will run out of money before we do.

The Emperor: [laughing] Perhaps you refer to the eminent attack of your rebel fleet? Yes, I assure you, we are quite safe from your friends here. Translated: Perhaps you refer to your army of expensive expert witnesses. They are no threat to us. I assure you we are prepared to destroy their testimony.

Luke: Your overconfidence is your weakness. Translated: Your overconfidence is your weakness.

The Emperor: Your faith in your friends is yours. Translated: Don’t count on the jury to bail you out of this one.

But lawyers are supposed to be confident, right? Yes, but there is a difference between having confidence and the courage of your convictions and overconfidence and the consequences of poor judgment. In an amusing analogy, Professor Loftus compares and contrasts lawyers and weather forecasters.

First, meteorologists cannot in any way influence the outcome of their predictions. Nothing they do can make it rain. Lawyers, on the other hand, can behave in ways that influence the case outcome. Because they have this opportunity, they may overestimate their own capacity and neglect the importance of factors beyond their control. Second, lawyers have a much keener interest in the goals of their predictions than do meteorologists. Because of this, lawyers might be susceptible to over optimism and wishful thinking.

The central focus of Professor Loftus’ study is the degree of accuracy in lawyers’ forecasts of case outcomes. To read the entire research paper click here. (PDF)  Meanwhile, the following quotes provide a glimpse of her insightful observations :

In summary, whether lawyers can accurately predict the outcome of a case has practical consequences in at least three areas: (a) the lawyer’s professional reputation and financial success; (b) the satisfaction of the client; and (c) the justice environment as a whole. Litigation is risky, time consuming, and expensive.

The consequences of judgmental errors by lawyers can be costly for lawyers and their clients, as well as an unnecessary burden on an already overloaded justice system. Ultimately, a lawyer’s repute is based on successful calculations of case outcome. A lawyer who advises clients to pursue litigation without delivering a successful outcome will not have clients for long. Likewise, a client will be most satisfied with a lawyer who is accurate and realistic when detailing the potential outcomes of the case. At the end of the day, it is the accurate predictions of the lawyer that enable the justice system to function smoothly without the load of cases that were not appropriately vetted by the lawyers.

A lawyer who cannot accurately predict the outcome of a case or who does not thoroughly and efficiently appreciate the litigation risks may ignore alternatives to trial and advise the client to reject reasonable settlement offers. A lawyer who underestimates potential outcomes may advise the client to accept an unreasonably lower amount in settlement than is warranted.

Another factor that might affect the realism of lawyers’ assessments of future goals is perception of control. The extent to which an individual believes he or she can take steps to increase the likelihood of a desirable outcome has been shown to bias confidence estimates in those outcomes. When an event is perceived to be controllable, overconfidence is likely. This bias is linked to what Langer (1975) called an illusion of control, defined as “an expectancy of a personal success probability inappropriately higher than the objective probability would warrant”.

Lawyers frequently made substantial judgmental errors, showing a proclivity to over optimism. The most biased estimates were expressed with very high initial confidence: In these instances, lawyers were extremely overconfident. These findings are consistent with a large body of literature documenting overconfidence in a range of judgments.

With regard to gender, we replicated results obtained by Malsch (1990) that female lawyers were better calibrated than their male colleagues. Male practitioners were more overconfident than female practitioners. These findings are in line with gender differences observed in research on metacognition.

One implication of the present findings is that lawyer performance can be improved by implementing case management strategies that take into account the potential overconfidence biases of the litigators.Case consultations with legal peers can take place informally. For example, in many legal firms, regular meetings are held where cases are periodically reviewed so that the partners can manage the caseload efficiently and ethically. These meetings provide ideal opportunities to obtain objective opinions from other legal professionals in the form of third-party feedback about the strengths and weaknesses of a case and the likelihood that the stated goals can be achieved.

This study shows that lawyers can be too confident. When lawyers do not fully assess the risks or acknowledge certain aspects of the case that may be beyond their control, over-(and under) valuations can happen, making settlement impossible. Objectivity requires lawyers to walk a fine line, some would call it a high wire balancing act, between zealous advocacy and wise counsel. Indeed, wisdom is the safety net that keeps litigators from crashing to the earth.

May the Force be with you.

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Construction claims for non-disclosure on public works projects got a little easier to prosecute yesterday with the publication of the California Supreme Court’s decision in Los Angeles Unified School District v. Hayward Construction. (PDF) The importance of this case is reflected by the list of attorneys who represented the parties, a veritable Who's Who in the legal community.The contractor and surety were represented by veteran construction lawyers John Immordino of Wilson Elser and Joseph Miller of Montelone & McCrory. The school district was likewise well represented by its General Counsel, Roberta Fesler, Gregory Bergman of Bergman & Darcey and lawyers at Jones Day, including Ellwood Lui, a former associate justice of the California Court of Appeal, Second Appellate District, Division 3..

In the Hayward Construction case, and for the first time, the Court was asked to resolve a construction dispute brought solely on a theory of non-disclosure during the bidding phase of a project. The question was whether a contractor can recover extra costs of construction when the plans and specifications are correct, but the public entity failed to disclose information in its possession that materially affected the cost of performance.

The case is also important because it resolves conflicting opinions between four of the California Courts of Appeal. One Appellate Court, followed by the trial court in the Hayward Construction case, held that to recover for nondisclosure, the contractor must show the public entity affirmatively misrepresented or intentionally concealed material facts that rendered the furnished information misleading. Another Court of Appeal held a contractor need not prove an "affirmative fraudulent intent to conceal" when disclosure would have eliminated or materially qualified the misleading effect of facts disclosed. A third Appellate Court suggested that the careless failure to disclose information may allow recovery if the public entity possessed superior knowledge inaccessible to the contractor. And the Appellate Court in the Hayward Construction case broadly held that a contractor need show only that the public entity knew material facts concerning the project that would affect the contractor's bid or performance and failed to disclose those facts to the contractor.

SUMMARY OF THE FACTS

Hayward entered into a contract with a school district to complete the work of the original contractor who was in default. The scope of the work was based on a 108 page “pre-punch list” and required Haywood to correct the defective, missing and incomplete work on a time and material basis up to a guaranteed maximum price.

Shortly after beginning work, Hayward informed the district there were significant deficiencies in the existing work that had not been noted on the pre-punch list and could not have been detected by a visual inspection. As a result, Hayward made a claim for extra compensation to perform this additional work. The district then sued Hayward and its surety and Hayward filed a cross-complaint against the district, alleging misrepresentation and concealment. In support of these theories, Hayward alleged the district failed to disclose the extent of the defects in the existing construction, and failed to disclose information that would have put Hayward on notice that some of its assumptions about the scope of the required work were erroneous.

After losing a motion for judgment of the pleadings in the trial court, Hayward won at the Court of Appeal, and then the school district appealed to the California Supreme Court.

THE COURT'S DECISION

The California Supreme Court affirmed but narrowed the court of appeal’s opinion in Hayward Construction, holding that a contractor need not prove an affirmative fraudulent intent to conceal. Rather a public entity may be required to provide extra compensation if it knew, but failed to disclose, material facts that would affect the contractor's bid or performance.

In narrowing the Court of Appeal's opinion, the California Supreme Court stated:

[W]e conclude the Court of Appeal's rule was, in turn, overbroad in suggesting that recovery may be had for any failure to disclose material information. Rather, we hold that a contractor on a public works contract may be entitled to relief for a public entity's nondisclosure in the following limited circumstances: (1) the contractor submitted its bid or undertook to perform without material information that affected performance costs; (2) the public entity was in possession of the information and was aware the contractor had no knowledge of, nor any reason to obtain, such information; (3) any contract specifications or other information furnished by the public entity to the contractor misled the contractor or did not put it on notice to inquire; and (4) the public entity failed to provide the relevant information.

The Court noted the circumstances affecting recovery may include, but are not limited to, positive warranties or disclaimers made by either party, the information provided by the plans and specifications and related documents, the difficulty of detecting the condition in question, any time constraints the public entity imposed on proposed bidders, and any unwarranted assumptions made by the contractor. The public entity may not be held liable for failing to disclose information a reasonable contractor in like circumstances would or should have discovered on its own, but may be found liable when the totality of the circumstances is such that the public entity knows, or has reason to know, a responsible contractor acting diligently would be unlikely to discover the condition that materially increased the cost of performance.

The is an important case in the construction industry. The risks of the bidding process became a little less risky. The uphill battle for contractors claiming extra work for unknown conditions got a little easier. They will still have to overcome the Spearin rule stated by the U.S. Supreme Court nearly a hundred years ago, that a contractor can not avoid its contractual obligations or seek additional compensation for performing them merely because unanticipated circumstances are encountered. Contractors will still have to get past disclaimers and other contractual language that attempt to place the burden of unanticipated conditions on them. But the Hayward Construction case now gives them some relief when making a claim for non-disclosure: they do not have to prove an intent to defraud; only a failure to disclose material facts that would affect the contractor's bid or performance.When such a claim arises, the contractor should make a demand for all documents in the owner’s possession, custody or control relating to the conditions of the project.

As for the parties in the Hayward Construction case, they are back in the trial court preparing for trial.

NOTE: Nine amicus curiae (friends of the court) briefs were filed in the Supreme Court of California on behalf of various organizations. Such briefs are often filed in appeals concerning issues of broad public interest. Four amicus curiae briefs were filed on behalf of various construction industry organizations, including the Associated General Contractors Association of California and the American Subcontractors Association. Five amicus curiae briefs were filed on behalf of various governmental organizations, including the California School Boards Association and The League of California Cities. The filing of these briefs by outstanding lawyers and law firms is another indication of the importance of the Hayward Construction case to the respective interests of construction professionals and public entities in California.

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It is an interesting paradox that construction professionals who devote their lives to building unique structures according to customized plans generally use "cookie cutter" form contracts to govern the duties and obligations of the parties. When a construction dispute arises, most construction professionals and their lawyers will spend many hours scrutinizing the contract documents to analyze their rights. Since so much time is spent evaluating the contract after the dispute, shouldn't there be at least an equal amount of time and thought put into it before the project begins? Instead of standard cookie cutter provisions, doesn't it make sense to think about the risks of the project and clearly define what will happen in the event of a dispute?  I have been preaching this sermon for many years, and recently posted an article on the subject called, Resolve Construction Disputes More Efficiently With Customized ADR Provisions.

A new case in California  (PDF) illustrates the benefit of customized contract provisions related to dispute resolution. The case involved the proposed development of a parcel of property and a contingent lease for a drug store build-out for Rite Aid. Here is the smart part of what happened: the lease agreement did not have the standard "prevailing party" language in the event of a dispute. Instead the lease stated that the prevailing party is entitled to "reasonable expenses," and then listed what the parties meant by that term: attorney fees, court costs, witness and expert fees.

The developer won the case and asked the court to award reasonable expenses including attorney fees and expert witness fees. Rite Aid challenged the developers request for $83,000 for expert witness fees in a motion to tax costs. The trial court denied the motion and Rite Aid appealed the judgment in favor of the developer, including the award of expert witness fees.

The California Court of Appeal affirmed the award of expert witness fees, holding that the the lease expressly called for them as an item of cost. The Court gave deference to the fact that this was a customized provision negotiated by sophisticated parties:

This does not mean-and we do not hold-that expert witness fees are recoverable in every case where "costs" are merely mentioned in a contract. A general cost provision should be interpreted according to the established statutory definition. But where sophisticated parties knowingly and intentionally negotiate a broader standard into their contract-and particularly where, as here, that standard specifically includes "witness and expert fees"-the intent of the parties should be upheld by the court. (Emphasis added.)

In most states, there are other ways to obtain an award of expert witness fees. I wrote about them in a post entitled, Settlement Negotiations: Don't Get Smacked By The Statutory Stick. But statutory awards of expert fees are discretionary awards made by the trial court after certain facts are established to the satisfaction of the judge. This Rite Aid case, on the other hand, provides a blue print for construction professionals who want to clearly define what will happen to the losing party in the event of a dispute rather than hoping for the favorable discretion of the trial court.

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Yesterday a district court judge appointed a special master to mediate a lawsuit between four major record labels and Jammie Thomas, a Minnesota woman who allegedly downloaded and distributed more than a thousand songs on the internet in violation of federal law. The case is deemed by many to be a vanguard in the music industry’s effort to thwart the practice of peer to peer (P2P) file sharing, which is costing the music world a bundle, according to industry experts. The strategy seems to be that the threat of a lawsuit and heavy fines will deter music lovers from unlawfully downloading and distributing music to their friends.

The special master/mediator, Jonathon Lebedoff, a former chief magistrate judge of the District of Minnesota, has a great deal of mediation experience-he was responsible for the settlement of the Dalkon Shield litigation, for example. Nevertheless, the good judge must overcome a number of barriers to resolve this conflict.

Barrier No. 1-Mediation is Less Likely to Succeed if it is Involuntary

Mediation is based on the premise that parties who voluntarily participate in the process and agree to devote their time, money, and resources toward problem solving will be sufficiently invested to find a way to resolve their dispute. In this case, the record industry and Ms. Thomas were ordered to mediate the case prior to July 16, 2010, and Plaintiffs’ representative, Recording Industry Association of America, was ordered to pay the special master $400 per hour to conduct the mediation. In my experience, parties who are ordered to mediate a dispute rarely have the requisite personal investment to fully engage in the mediation process and maximize the opportunity to settle the case. They simply show up to comply with a court order but their hearts are not into it. Furthermore, unless the parties decide it is in their mutual best interest to have one side pay for the mediator, it is unwise to force one side to pay for the mediator because the side being forced to pay the full freight will resent it and the side going along for the free ride will not be sufficiently invested in the process to care if it succeeds or not.

Barrier No. 2-Bad Timing Can Destroy the Chances of a Successful Mediation

The best time to mediate a case is when both sides feel they have sufficient information to analyze the risks of trial and calculate the reasonable range of settlement. If parties attempt to mediate too early, the defense may feel it needs more information before a reasonable offer can be made; mediate too late and the plaintiff may have spent so much money on the litigation that its only viable option to recoup its fees and costs is to proceed with trial. If you wait to mediate the case until after the verdict, then the prevailing party has less risk to consider and will be less flexible in the negotiations.

In the Jammie Thomas case, the special master/mediator is being asked to mediate a dispute that has already resulted in two jury verdicts in favor of the record companies. The first trial resulted in a jury award of $222,000 in statutory damages which was thrown out by the trial judge. The second trial resulted in a jury award for $1,920,000 in statutory damages which the trial judge reduced to $54,000.

Thus Judge Lebedoff must try to facilitate a settlement by helping Ms. Thomas see the wisdom of  paying all or part of the $54,000 and convincing the record companies to waive their right to appeal the trial judge’s reduction of their seven-figure verdict. This will not be easy.

Barrier No. 3-Litigation Risk Analysis Should Include Collectability

Assuming liability and damages have been properly analyzed, the collectability of a judgment must be factored into a litigation risk analysis. In other words, does the defendant have sufficient assets to satisfy a judgment? If not, it may be very difficult to settle the dispute. With nothing to lose, a party may not feel it necessary to work out a compromise.That seems to be the case with Ms. Thomas.

Ms. Thomas is a young mother of four who works as a natural resource coordinator for the Millie Lacs Band of Ojibwa Indians. While I know nothing about her finances, it is interesting that the record companies are the ones who seem anxious to get the case settled, not Ms. Thomas. Perhaps they realize that they are spending a lot of money to enforce a judgment that may not be collectable.

Greg Sandoval of CNET News reported in January 2010 that Ms. Thomas rejected a settlement offer of $25,000. In response, according to Mr. Sandoval, the record companies released the following statement, "It is a shame that Ms. Thomas-Rasset continues to deny any responsibility for her actions rather than accept a reasonable settlement offer and put this case behind her[.]"

Barrier No. 4-A Zero-Sum Attitude in a Dispute Resolution Setting

Commercial mediation works very well when all the parties share the same objective: the resolution of a dispute. But when a party simply wants to prove it is right and that the other side is wrong, reason or logic rarely prevail in a mediation session. This zero-sum attitude does not take into account the emotional and financial toll of a trial, an appeal, and perhaps more trials and appeals.

This seems to be the situation that Judge Lebedoff faces as the mediator in the Jammie Thomas case. One of her defense lawyers told CNET that they have always sought a $0 award and that the defense lawyers planned to challenge even the reduced damage award. And though the Plaintiff record companies appear to want to settle the case, Mr. Sandoval reports that they would be just as happy to appeal the ruling of the district court judge that greatly reduced the statutory damage award.

Fortunately, all of these barriers can be overcome if the parties will set aside their trial advocacy skills and focus on their negotiation advocacy skills.This change in attitude coupled with the problem solving skills of Judge Lebedoff can overcome any barrier that may exist. Best wishes to Judge Lebedoff and the parties in the upcoming mediation.

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I like Abraham Lincoln’s adage about preparation: “If I had eight hours to chop down a tree, I'd spend six hours sharpening my ax.” This post is about sharpening our negotiating axes through a pattern of preparation that includes rigorous legal analysis. My friend and fellow mediator, Don Philbin of San Antonio, Texas wrote one of the finest articles I have read on the subject entitled, “Prepare for Mediation: A Multidisciplinary Approach to Negotiation Preparation." You can read his article by clicking here. (PDF) It will surely sharpen your negotiation skills and help you efficiently resolve many difficult disputes. Here is a summary of Don's article:

1. Rigorous Legal Analysis Forms the Basis Negotiation Preparation.

 [Preparation] is the be-all of good trial work. . . . Everything else, felicity of expression, improvisational brilliance, is a satellite around the sun. Thorough preparation is that sun.         -Louis Nizer

In reviewing the essentials of the rigorous legal analyses that lie at the base of any economic analysis, New York litigator Louis Solomon concludes that “the importance of intelligent, critical, analytical, yet realistic case evaluation cannot be overstated.” Solomon notes that case evaluations should begin early and be updated consistently, including at certain regular intervals.The goal is assessing risk, not achieving perfection. In a recent article, he condenses the evaluation process into five key steps:

identify potential issues;

evaluate issue relationships and overall case bearing;

evaluate the risk or probability of each outcome (fact and law intensive);

evaluate possible upside and downside exposure; and

identify the indirect and collateral issues from the client’s perspective.

2. Decision Tree Analysis Helps Develop and Test Scenarios

In decision tree analysis, you establish the key events of the litigation through trial. You then estimate the probability for success of the key events and the dollar values of the potential final outcomes. A decision tree visually depicts this process in as much detail as may be desired. A more complex decision tree may include the chances of success of potentially dispositive motions, such as summary judgment, or the impact of rulings on certain key evidence. On the other hand, a basic decision tree may only depict liability and damage issues.
 
When evaluating liability and damages, you start with the basic question: what is the chance of prevailing on the issue of liability? If liability can be established, what is the amount that will be awarded for damages? The outcome will provide a range for settlement purposes

The process itself is as valuable as the result because it structures our analysis and focuses our attention on the component parts of the problem. In considering the range of outcomes and their probabilities, the parties not only come to a more realistic view of their options, they are able to communicate those scenarios in a common vernacular.

You can read my post on decision trees entiled, Dispute Resolution, Decision Trees, and Albert Einstein by clicking here.

3. Anchoring

As we move from dispute analysis to negotiation planning, we are often faced with the decision to either make the first offer or await one from the other side. That decision turns on a number of variables. One commentator argues that anchoring “describes the process by which the human mind does virtually all of its inferential work.” Anchors function much like our “gut” reactions to the value of an object or lawsuit – the “thin slice” our subconscious sends our conscious mind to evaluate. The more relevant information our analytical mind has, the less we are swayed by an unreasonable anchor. Mistaken or misguided anchors can increase the odds of impasse and have other unintended consequences.

4. Preparation Provides a Framework for Options

Litigants must make choices [about the claims] or turn them over to others for a binding decision. Unwilling to drain every swamp looking for evidence, they are often faced with making decisions with less than perfect information. The challenge then is to make the best decision with the information they do have or budget an appropriate amount based upon the developed choices. Economic analysis helps narrow the field from the legally possible to the economically viable

Outstanding trial lawyers spent considerable time and effort honing their skills to be effective courtroom advocates. But since most cases settle before a verdict is reached, it is equally important to develop effective negotiation advocacy skills. I hope you will spend some time with Don's article to help you sharpen your ax.

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Bear with me as I pay my respects to a lifelong hero who influenced my life for good:

John Wooden, the Wizard of Westwood, was the greatest coach of all-time. He passed away June 4, 2010; 4 months shy of his 100^th birthday. While he will be remembered for his 10 NCAA basketball championships as the head coach of the UCLA Bruins, he always considered himself first and foremost a teacher. He taught principles of living based on his Pyramid of Success, and shared his wisdom through sayings that have been quoted for decades in virtually every educational, athletic, professional, and business forum and setting.

Even though I was never very good at handling a basketball (giving hard fouls was my forte), I have been pretty good at finding ways to sharpen my skills as a negotiator and a mediator.

 Here are a few of the things I learned from Coach Wooden’s playbook:

• PREPARATION: “Failure to prepare is preparing to fail.”
• HARD WORK: “Nothing will work unless you do.”
• PATIENCE: “Do not let what you can not do interfere with what you can do.”
• PERSEVERANCE: “It’s not so important who starts the game as who finishes it.”

And here is how I have applied these sayings of his to the field of negotiations and dispute resolution:

1. If you do not prepare for mediation, you are preparing for the mediation to fail. Claims are not settled in a vacuum, they must be rigorously measured against the realities of trial before the negotiations begin. Questions about liability and damages, evidence and admissibility, costs and fees, must all be evaluated; the impact of litigation and trial on clients in terms of time, emotion, and resources must be scrutinized; and an objective study of the strengths and weaknesses of the other side’s positions must be undertaken in advance of the mediation. This is not to say that extensive discovery on every conceivable issue must be completed but sufficient thought must be given to these issues to enable you to negotiate to the best of your ability and with your client’s best interests in mind.
2. Mediation does not work unless the parties are willing to work on both objective and subjective levels. They work better when lawyers are willing to set aside trial advocacy skills in favor of negotiation advocacy skills.  They work best when both sides focus on finding ways to resolve the dispute instead of perpetuating it.
3. Do not let the tactics of the other side interfere with the implementation of your settlement strategy. You can not control your opponent but your preparations will enable you to take control of the negotiations by anchoring the offers and demands within a reasonable settlement range based on the facts of the case, the applicable law, and the record of verdicts in similar cases. Studies have shown that the first party to make a reasonable demand or offer anchors the negotiations in his favor. Thereafter, the negotiations tend to be driven in that direction.
4. Have the mindset that you are going to see the mediation process through to the end. Be prepared to endure the ups and downs of a mediation session. Don’t allow your emotions to take you out of your game plan. Unfortunately, I see this happen all too often. For example, plaintiff believes the reasonable range of settlement to be $500,000 to 250,000. The defense, believes the settlement value is between $150,000 to 225,000. In other words, unbeknown to each other, they begin the negotiation with only $25,000 separating Plaintiff’s potential lowest demand and the defendant’s potential highest offer. However, the plaintiff wants to give himself plenty of room to negotiate so he makes an initial demand of $1,000,000. The defendant’s reacts emotionally to this number: “It’s outrageous; they are not negotiating in good faith; I’m not even going to respond with a counter offer.” After some time, defendant may respond with an equally ridicules number, $25,000. How does the plaintiff react? The same way and before you know it, both sides become frustrated and the mediator declares an impasse. If you are going to convene mediation, be prepared to finish the process. Allow the mediator to help the parties work through the process to find clarity and to maximize the chances for a reasonable resolution of the dispute.

Mediators are not miracle workers; they can not create a settlement out of thin air, and no amount of their “hot air” will convince parties to settle a case that has not undergone rigorous analysis by both sides. Take a page from Coach Wooden’s playbook: prepare, work hard, control what you can, and endure to the end. And when you are in the middle of a difficult negotiation, remember one more thing John Wooden taught, "Flexibility is the key to stability."

Thank you, Coach Wooden. Thanks for everything.

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Parties hungering for their day in court must digest the potential repercussions of the carrot and stick procedures enacted by their respective legislatures to encourage the pre-trial settlement of disputes. Federal Court Rule 68 provides that a plaintiff whose judgment is less than defendant’s statutory settlement offer may be required to pay defendant’s costs, including deposition costs, filing fees, and other costs incurred after the offer expires. In certain cases, Rule 68 can also be used to cut off plaintiff’s claims for attorney fees incurred after the settlement offer.  Some state courts rules, such as California’s Code of Civil Procedure section 998 and Texas’s Rule 167, add to the list of recoverable costs, attorney fees and expert witness fees in cases where the terms of the statutory settlement offer were more favorable that the final judgment. 

It has been suggested that the correct usage of the carrot and stick idiom is actually “carrot on a stick,” referring to the hapless donkey tricked into pulling a cart by the lure of a carrot dangling from a stick. But studies have shown that rewards alone have little impact on cooperation among human beings, although punishment alone can be motivational.  But when rewards and punishment are combined the effect on cooperation is dramatic, suggesting that the more realistic image of the donkey and the cart would have the driver holding the stick attached to a carrot in one hand and a prodding stick in the other. Similarly, in civil trial courts, the benefits of compromise alone may not be enough to induce parties to negotiate in good faith, but when combined with the threat of having to pay the other side's costs, litigants are generally sufficiently motivated to settle their lawsuits.

In California, for example, a party may serve a written offer to compromise prior to trial, and if the offer is rejected and the opponent does not receive an award at trial greater than the offer, then the party that rejects the pre-trial offer may be ordered to pay the offeror's costs. This gives the parties strong financial incentives to make reasonable settlement offers and burdensome disincentives to discourage the rejection of them.

Unfortunately, some litigants do not even consider the possibility of paying the other side's costs when considering the settlement value of their cases, or, in some states where attorney and expert witness fees can be awarded, they make the mistake of only evaluating general litigation costs such as filings fees, the cost of deposition transcripts, and service of process fees.  When a statutory pre-trial offer is made, the trial lawyer must understand that the offer has created a floor that must be exceeded in order to collect his costs and avoid having to pay his opponent’s litigation costs.

The possibility of a statutory offer of settlement can induce parties to participate cooperatively during a mediation session. In preparation for mediation, counsel will usually calculate the settlement value of a case by analyzing the likelihood of success at trial both as to liability and damages. The damage estimate will then be discounted by some percentage to reflect the possibility that the trial will not proceed according to plan. If, however, counsel must also consider whether the damage award will exceed the amount of a "statutory offer," then the analysis becomes more complicated and the stakes at mediation increase.

For example, suppose plaintiff's counsel believes his case is worth $1,000,000 in damages, but for purposes of settlement discussions considers $800,000 as a reasonable amount for settlement. Without the carrot and stick of a statutory pre-trial offer, plaintiff's counsel need only worry about the other side's costs if no money is awarded at trial. Being extremely confident, counsel considers the likelihood of a jury awarding nothing to be zero. Therefore, counsel concludes $800,000 is the minimum amount that should be accepted at mediation.

On the other hand, suppose counsel's preparation includes an analysis of the other side's costs and what would have to be achieved at trial to avoid having to pay them, and then he fully explains the ramifications of statutory offers to his client.prior to the mediation. Now he will be better prepared to evaluate the risks of trial should the other side's best offer be less than he expected, say $500,000. As a result, plaintiff's counsel will be in stronger negotiating position and better able to meet the needs of his client, knowing the likely floor that he must exceed at trial in order to prevent his client from having to pay defendant's costs which, for a million dollar case, could be hundreds of thousands of dollars..Given this risk, plaintiff's counsel will be more willing to come off the original  $800,000 target number during mediation.

The possibility of paying the other side's costs, especially if they include attorney and expert fees, is a powerful incentive to negotiate in the utmost good faith. As demonstrated above, the cost-shifting feature of statutes such as Federal Rule 68 and California Code of Civil Procedure section 998 can be a carrot to entice reasonable settlement offers and a big stick to discourage rejection of settlement offers. Use this tool to your advantage at mediation. You will increase your negotiating leverage while demonstrating that you are a wise steward of your client's litigation dollars.

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This is part two of my series regarding insurance coverage issues in construction defect cases. In part one, I addressed common indemnity and defense issues. In this post, I will address how excess policies come into play when the exposure to liability for construction defects exceeds the policy limit of your primary insurance policy, typically a commercial general liability or CGL policy.

Depending on the size of the project, many contractors will have an added layer of insurance protection in the form of an excess or umbrella policy. These are policies that provide additional coverage for claims that exceed the limits of primary coverage and can be purchased for a relatively modest sum, compared to the premiums for primary insurance coverage.

Construction defects, which typically manifest slowly over time, will likely implicate the successive primary insurance policies of the general contractor and its subcontractors on large projects, and quite possibly their respective umbrella or excess policies. The questions of which excess policies are subject to the claims and when does an excess carrier’s duty to defend arise are common issues and often stand as barriers to the resolution of construction defect cases. The case of Padilla Construction v. Transportation Insurance Co. (PDF) illustrates some of these complexities.

Padilla Construction was a stucco subcontractor to a developer who was sued by the owners of two houses in an upscale development in Castro Valley, California. The developer filed a cross-complaint for indemnity against Padilla.  The primary defect claims that evolved over a seven year period included foundation drainage problems, excessive crawl space moisture problems, and decay and mold contamination to the under-floor framing. Padilla’s work was implicated by the allegations that the foundation vents at some locations were blocked with stucco.

Padilla was covered by various primary policies over an eight year span and one excess policy for two of those years.  The Court of Appeal summarized the applicable policies as follows:

          
The insured had four successive primary liability policies from January 1995 until March 1, 2003:
—From the beginning of 1995 to end of 1996: Transcontinental Insurance.
—From the beginning of 1997 to end of 1997: Reliance Insurance.
—From the beginning of 1998 to March 1, 2001: Legion Indemnity.
—From March 1, 2001, to March 1, 2003: Steadfast Insurance. Editor's Note: These policies required Padilla to pay $25,000 in self-insured retention (SIR) before Steadfast’s obligations came into effect.

Additionally, coincident with Transcontinental's primary policy (Jan. 1995 through the end of 1997), the insured had two yearly commercial umbrella policies issued by Transportation Insurance Company.

In tabular form, over the period of the continuing loss, the policies may be expressed this way:

Initially, Padilla tendered its defense to Transcontinental which was accepted. On the other hand, Reliance and Legion were insolvent and nothing was available from either carrier by way of defense. Padilla did not want Steadfast to get involved because it did not want to pay the $25,000 self-insured retention. Instead, when the Transcontinental policy was exhausted due to the payment of defense and indemnity costs on the Castro Valley project case and other claims, Padilla tendered the defense to its excess carrier, Transportation, on the basis that all other primary policies were either exhausted or their carriers were insolvent, and that there was no primary insurance available under the Steadfast policy because Steadfast had no obligation to defend due to the self-insured retention requirement. In other words, Padilla did not have any primary insurance through Steadfast unless and until Padilla paid the first $25,000 in defense or indemnity costs.

Eventually the parties in the Castro Valley project case reached a settlement, which included a $60,000 contribution from Padilla who, in turn, filed the subject insurance coverage case against the excess carrier, Transportation. The trial court ruled in favor of the excess carrier and the California Court of Appeal affirmed, stating that  “an excess insurer does not have a duty to defend an insured until ‘primary insurance’ in the form of a so-called ‘self-insured retention’ is exhausted applies here. The statement obtains with just as much force even if the excess insurer's 'other insurance' clause does not contain a direct reference to 'self-insurance'.

For a variety of reasons, the Padilla case is useful reading for anyone facing construction defect claims and trying to figure what insurance may be available to defend and indemnify the claims.

1. The way the Court organized the chronology of the applicable insurance policies is a good template for anyone trying to figure out the availability of insurance.
2.  There is a good discussion of the duty to defend in construction defect cases involving continuous damages. In the Padilla case, the blocked vents led to allegations of damages that spanned several years and therefore, implicated many policies. Thus even though the inception of the loss occurs in the policy period of one policy, the continuous nature of the damages can spill into the policy periods of additional carriers, making the successive carriers also  responsible for the defense of the claims.
3. The case points out that in California, anyway, the duty to defend the whole action arises when any portion of the damages falls within the policy period, even though the increments of harm preceding the policy period would not be covered by way of indemnity, reminding us that a carrier’s duty to defend is broader than its duty to indemnify.
4. We are also reminded that a carrier can seek reimbursement from its policyholder for defending that portion of the claims that may come before the inception date of the policy. Thus the good news in that situation is the carrier may have to fund the defense of all of the litigation, even the defense of damage claims that precede the policy, but the bad news is the carrier has the right to seek reimbursement for defending the uncovered damages.
5. Self Insured Retention or SIR must be paid and the primary policy exhausted before the excess carrier is required to defend and indemnify a claim.
6. The case has a good definition of self-insured retention: “while there ‘is no dispositive case law differentiating deductibles from SIRs,’ a deductible ‘usually relates only to the damages sustained by the insured, not to defense costs’ where an ‘SIR is generally a specific amount of loss that is not covered by the policy but instead must be borne by the insured.’”
7.  The case also provides a good explanation of the differences between excess and umbrella policies:" Technically, there is a difference between umbrella and excess policies. Umbrella coverage is a "type" of excess coverage, typically providing, as in the present case, for losses for which there may be no "underlying' insurance." The other type of excess coverage is "‘following form" coverage” which, as the name indicates, follows the form of a specific underlying policy. Because umbrella insurance provides coverage ‘for certain losses for which there may be no underlying insurance,’ they provide ‘broader coverage than the underlying insurance. By the same token they provide broader coverage than “form following” excess policies."
8. Finally, the case identifies the timing of when an excess insurer is obligated to defend a lawsuit in California: "The rule of “horizontal exhaustion” in liability insurance law requires all primary insurance to be exhausted before an excess insurer must “drop down” to defend an insured, including in cases of continuing loss. Unless there is excess insurance that describes underlying insurance and promises to cover a claim when that specific underlying insurance is exhausted (“vertical exhaustion”), the rule of horizontal exhaustion applies to cases of alleged continuing property damage—as often happens when the insured is sued for construction defects."

Being knowledgeable about insurance is the first step in the process of getting a carrier to defend and indemnify defect claims but, as Malcolm Gladwell said in his marvelous book,Blink,: ”The key to good decision making is not knowledge. It is understanding. We are swimming in the former. We are desperately lacking in the latter (p.265).” When construction defect claims arise, it is not enough to know you have excess insurance coverage. Padilla Construction knew it had an excess policy but did not understand  when or how to access it. I hope this post (and my prior one) will help you understand how to secure the full extent of insurance protection that is available to you.  

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It is a fact that a high percentage of construction disputes are resolved through mediation in the United States. Although the voluntary, collaborative nature of the mediation process seems inimical to the highly competitive, hard-charging  world of  the U.S. construction industry, the record of success is quite impressive. It would seem, then, if mediation can thrive in the U.S., it can also work in other countries.

 I have often thought that mediation is especially well-suited for the resolution of disputes involving Japanese entities. In Japan (and other Asian cultures), saving face, honor and loyalty remain fixed in the Japanese character. I learned a lot about this during the two years I lived there. Frankly, as a Westerner, in some ways it was harder to comprehend the culture than it was to learn the language. For example, it took me a little while to apprehend  the Japanese tendency of avoiding public conflict. In my first few months there, I am sure I offended some people because I did not appreciate the fact that what appeared to me to be evasiveness was actually an attempt to avoid conflict and public embarrassment-mostly mine. Now as a mediator, I can see that private mediation can help Japanese construction professionals resolve their disputes in an honorable way, consistent with their culture and traditions.

Prominent construction lawyer Robert S. Peckar recently posted an outstanding article in Who'sWhoLegal about the application of U.S.-style mediation in other countries. I have quoted below parts of the article that explain the mediation process and other parts which explore its benefits and barriers in the context of international construction disputes.

US-style mediation is the voluntary participation by disputing parties in negotiations facilitated by a third-party neutral known as the “mediator”. The mediator typically is a lawyer (although he or she need not be) who is trained in the art of negotiation used in the mediation process. The key elements of the typical mediation process are:

• The process is voluntary. While some speak of “binding mediation”, that term is misleading. The only aspect of mediation that is binding is the agreement made by the parties to settle their dispute (more on that later). All parties must agree to participate or there is no mediation. Although some contracts require mediation as a condition precedent to the next step in the process, there is agreement at least at the time of contracting.
• Because the process is voluntary, the parties are making a commitment that they are willing to listen, to learn, and to make compromises to achieve a fair settlement with the other party.
• The process depends on the good faith of all parties to participate with an open mind and a desire to settle.
• The process is conducted under the guidance of a mediator, who is selected by all of the parties because they trust and respect the mediator’s skills, knowledge and integrity. The mediator is neutral and independent. The mediator typically is highly trained in the art of negotiation and mediation, knowledgeable in construction, and experienced in construction law. Mediation simply introduces a trusted expert into the negotiation process to facilitate a resolution of the dispute. There are several organizations that offer mediation services to members of the construction industry.
• Before and during the mediation, the mediator is provided with confidential information from each party about the strengths and weaknesses of their case, their settlement goals, financial concerns that might affect the settlement, personal relationships impacting settlement, other matters of value to each party, such as maintaining relationships or receiving expedited payment, and other confidences that may assist the mediator. Armed with this information, the parties’ trust and negotiation skills, the mediator is in an excellent position to guide the parties to an acceptable settlement.
• US-style mediators act in a facilitative manner, however, many will be quite strong in providing advice to the individual parties during their confidential sessions. That advice may range from “encouragement” that a party modify its position in order to achieve a settlement to a polite confrontation in which the mediator informs the party in clear terms why the mediator believes that party is not properly advancing the potential for settlement. The mediator may explain to the party that its resistance to make meaningful counter-offers is unhelpful. The mediator may also express a belief that the party is operating on an erroneous legal or factual position or that it is attempting to use a negotiating strategy that simply will not work. Many of the most successful construction-industry mediators in the United States are respected for their ability to bring strong guidance and the personal qualities of effective facilitation to the mediation process.
• Because of the sensitivity of the information provided to the mediator, the parties must have complete trust that he or she will maintain its confidentiality and help them reach the best settlement possible. Trust in the mediator is the cornerstone of a successful mediation.
• The mediator acts as an “honest broker of information” and never shares one party’s confidential information with another party without express permission. Thus, the parties are able to talk with the mediator about various options, including their “bottom-line number”, and other highly confidential considerations, without fear that they will be improperly disclosed to any other party. Mediators treat this obligation as a matter of sacred trust and do not violate that trust. Furthermore, the laws in most US states provide that all communications (oral and written) during the mediation process are confidential and may not be repeated in a legal proceeding.
• The mediation progresses through a rather predictable process to conclusion. Typically there are short pre-mediation submissions exchanged between the parties and with the mediator, an opening joint session, at which all the parties make presentations to each other about their case and their perceptions of the other parties’ cases, followed by a series of private caucuses with the mediator held in separate rooms. However, the parties are not constrained by a specific format and joint sessions may follow a caucus, sessions may be held with principals only and the mediator, or any other process may be used that will help achieve settlement. Flexibility is a key to mediation.
• An important element of the opening session of mediation is that the parties speak to each other and in particular the principals, not to the mediator. Sometimes the opening session is the first time a principal has heard a fair presentation of the other party’s position. The mediator is not a judge or arbitrator; and therefore, there is little advantage to try to convince the mediator of the merits of the party’s position. That shift in emphasis, from speaking to the third-party finder of fact to speaking directly to the other party, is at the heart of what makes mediation successful. The mediator’s role is to keep that dialogue appropriate in tone and direction both in the opening public session and then in the private caucuses.
• The mediator tries to help the parties focus on what is in their best business interests as opposed who is right or wrong on the issues, since it is often difficult to convince someone that they are wrong, and the matter may have little to do with a party’s best interest as far as settlement is concerned.
• The mediator helps the parties remove emotional issues or personal conflicts from the negotiation.
• The mediator has the ability to use many well-tested closing techniques to achieve the final resolution.
• Finally, in certain circumstances and as a last resort, the mediator can offer his or her opinion on certain issues and can suggest a settlement to assist the parties. If the parties trust the mediator, his or her opinion or suggestion may be enough to cause them to make the last move to settlement.
• The mediation process continues until a settlement is achieved by the parties or until the mediator (not the parties) concludes that settlement is unachievable and declares an “impasse”, at which time the parties revert to the formal dispute resolution process provided in their contract or as required by law. It is not unusual for mediation to continue late into the night or continue day-to-day with little time for sleep as momentum towards a settlement increases. It is also not unusual for the mediation to be postponed after the parties have exchanged information, discovery has occurred, or the parties have reassessed their positions and interests. The passage of time can be used to facilitate settlement.
• If the parties reach a settlement, they sign a settlement memorandum or agreement on the spot, in the mediation room, to avoid the chance that they will sleep on their agreement and change their minds the next day.
• The parties’ lawyers play an important role in mediation. They advise their clients throughout, may make presentations, and, if they are experienced in the mediation process, can help their client and the mediator steer through the challenges of mediation. However, unlike arbitration and litigation, jurists are not the central figures in the drama. At the end of the day it is the client who has control of the company’s destiny in mediation, as the client is the decision maker who must make the choices on what to say, when to say it, and whether to accept a settlement.

In summary, mediation in the United States is a negotiation in which an independent, trusted expert in negotiation and construction law is inserted between the parties, is provided with all of the parties’ confidential information, and then, armed with this information, tries to guide the parties to a settlement. It has a very high success rate. So, why wouldn’t the rest of the world jump at the chance to settle international construction disputes through US-style mediation as often as the construction industry in the United States?

Mr. Peckar describes some of the challenges of international mediation as follows:

 However, in the truly international case that brings parties from different parts of the globe together, the confidence that a mediator and the process will be conducted in a way that is “comfortable” for that party is often not present. For example:

• International parties to construction disputes may approach any negotiation with very different perspectives on how to negotiate. For parties from some countries, it is culturally unacceptable to offer or accept a reduced amount or to even share a willingness to settle for less with the mediator, as to do so may be perceived as personal weakness. It may be more acceptable for parties from such countries to lose in arbitration or court than to make concessions voluntarily. Such attitudes make the mediator’s job very difficult. An example of a particular issue that has resulted in non-US parties becoming uncomfortable about a US-style mediator’s approach to the facilitation of a settlement is the following: US-style mediators typically remind the parties of the expense they will suffer if they fail to settle their disputes and go on to arbitration or litigation. That reminder is accepted and often appreciated by construction-industry members in a dispute in the United States. Some international parties have been heard to complain that such a consideration is not relevant or even appropriate in a discussion about how much to pay to or accept from the other party.
• The language barrier can present tremendous problems, even with a translator. How easily can a party trust someone who does not speak their language? This becomes even more of a problem if the mediator speaks the adversary’s language.
• For parties from some countries, because the mediator goes into a room with the other party for hours (the caucus) to discuss the dispute this can be extremely worrisome and can undermine their trust in the mediator and the process.
• For others the sharing of highly confidential information, particularly if the mediator does not share their nationality, culture, or religion, is very difficult. As a result, even if they participate in the mediation they may be unwilling to share their confidences, which will make it less likely that the process will be successful.
• For some, the mere fact that they have never participated in mediation before, but have been in court or arbitration, is sufficient reason to reject mediation.

Construction disputes happen in all parts of the world. Regardless of cultural differences or legal traditions, all construction professionals want to resolve their disputes as efficiently as possible. Given the high settlement rate of mediated disputes in the United States, reasonable businessmen and legal counsel everywhere should find ways to implement mediation as an alternative dispute resolution method in their respective countries. The alternative to mediation is a fight in a court of law or in an arbitration proceeding. Mediation provides a confidential forum to fully explore both sides of a dispute with the knowledge that the failure to reach a compromise will lead to increased legal fees and costs and an uncertain outcome at trial. Indeed, the wisdom of mediation is reflected in two of my favorite Japanese proverbs: (1) Even a sheet of paper has two sides and (2) A good sword is the one left in its scabbard. 

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