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

The very first sentence of a recent opinion of the California Court of Appeal (PDF) frames the essence of a prime contractor’s multi-million dollar claim on a public works project known as the Hyperion Wastewater Treatment Plant: 

The City of Los Angeles (City) obtained millions of dollars worth of construction work that it does not want to pay for.

And the third footnote in the opinion reads like a consumer products warning label for construction lawyers:

The pretrial proceedings and trial presented the trial court with difficult legal and logistical issues that were made even more difficult by the inability of trial counsel to adequately define the case and state the law. Given this context, the trial court‘s effort to resolve these issues was admirable.

This preamble to the Dillingham-Ray Wilson v. City of Los Angeles opinion leads THE CRITICAL PATH to state the obvious (something I have a keen eye for): construction claims are complex, judges are usually not experts in construction law matters, and lawyers may find it difficult to reduce complex concepts in ways that are meaningful to the judge or the jury. For these reasons and more, the risks and uncertainties of trial are enormous, even for the most sophisticated parties and experienced construction lawyers. as illustrated by this case.There are, however, some dispute resolution tools that can be forged from the pages of the opinion:

• Proving Damages. When evaluating a construction case, you must carefully consider the question of how you will prove damages. Oftentimes an inordinate amount of time and money is spent discovering facts to support liability but the issue of damages is not fully vetted until it is time to prepare for expert depositions and trial. You have to begin your case evaluation with the end-damages-in mind. When it comes to obtaining a verdict, proof of liability without proof of damages is no proof at all.
• Method of Proving Damages. There are various methods for proving damages in construction claims: the actual cost method, the jury verdict method, the total cost method, and the modified total cost method. The acceptance of these methods of proof varies from state to state and between some state and federal courts. However, the Dillingham-Ray Wilson case recognizes the viability of the modified total cost method in California." In the published portion of this opinion, we conclude that the trial court erred because section 7107 and Amelco impact the measure of damages, not the method of proving them, and also because a modified total cost theory is permissible."
• Motions in Limine. When evaluating the likelihood of success, you have to anticipate motions in limine that can gut your case. In the Dillingham-Ray Wilson case, for example, the trial court granted an in limine motion and excluded from evidence $25 million of the contractor’s claim on the theory that it could not document its actual costs as required by contract. Of course, this ruling was reversed on appeal but that only means the contractor will have a second  trial with no guarantee that the new jury will award any damages.

These points should be among those you consider when evaluating the likelihood of success at trial. It is not enough to say, “My chances are 50/50 or 70/30.” Your risk analysis should break down each key element and evaluate the likelihood of success for each one. Your risk analysis should include a hard look at your damages and how you will prove them up. You should consider your chances of getting all of your evidence into trial by anticipating potential motions in limine. You should be sure you know the law and each element that you must prove and fashion your discovery plan around those elements.

What does all of this have to do with dispute resolution? Everything. Mediation is at one end of the ADR spectrum and trial is at the other end. Both processes resolve disputes; litigants retain control in mediation, but they lose control at trial. The Dillingham-Ray Wilson case is a good illustration of this fact. Once the trial begins, you lose control of the evidence. The judge decides what will be admitted into evidence. Once your closing argument is over, you lose control of the outcome of the case. The jury will decide the winner and the loser. Preparing your case with the end in mind will increase your ability to establish the realistic value of your case. Litigants who do this usually find a way to resolve their dispute before trial

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Tyler Gerking of Farella Braun + Martell LLP recently posted that Kemper Insurance is close to being put in a liquidation proceeding. According to Kemper's website, as of January 1, 2008, Kemper Insurance Companies in the U.S. included Lumbermens Mutual Casualty Company and its affiliated property and casualty insurers:

• American Manufacturers Mutual Insurance Company
• American Motorists Insurance Company
• Kemper Casualty Insurance Company
• Kemper Insurance Company of Texas
• Specialty Surplus Insurance Company

If you have a claim or potential claim on a commercial general liability policy or some other Kemper policy, you should check out Tyler's post. Here are some of the highlights:

But Kemper’s year-end financials for 2009 indicate that it is perilously close to the edge of the proverbial cliff. Lumbermens Mutual Casualty Company, Kemper’s largest member company, has only about $8 million in policyholder surplus available, down from just over $113 million one year ago. Kemper’s other large member company, American Manufacturers Mutual Insurance Company, reported a policyholder surplus of only about $11 million. Since these numbers were reported, we’ve noticed a considerable increase in chatter suggesting that Kemper may be in its final days.

But Kemper’s year-end financials for 2009 indicate that it is perilously close to the edge of the proverbial cliff. Lumbermens Mutual Casualty Company, Kemper’s largest member company, has only about $8 million in policyholder surplus available, down from just over $113 million one year ago. Kemper’s other large member company, American Manufacturers Mutual Insurance Company, reported a policyholder surplus of only about $11 million. Since these numbers were reported, we’ve noticed a considerable increase in chatter suggesting that Kemper may be in its final days.

But Kemper’s year-end financials for 2009 indicate that it is perilously close to the edge of the proverbial cliff. Lumbermens Mutual Casualty Company, Kemper’s largest member company, has only about $8 million in policyholder surplus available, down from just over $113 million one year ago. Kemper’s other large member company, American Manufacturers Mutual Insurance Company, reported a policyholder surplus of only about $11 million. Since these numbers were reported, we’ve noticed a considerable increase in chatter suggesting that Kemper may be in its final days.

But Kemper’s year-end financials for 2009 indicate that it is perilously close to the edge of the proverbial cliff. Lumbermens Mutual Casualty Company, Kemper’s largest member company, has only about $8 million in policyholder surplus available, down from just over $113 million one year ago. Kemper’s other large member company, American Manufacturers Mutual Insurance Company, reported a policyholder surplus of only about $11 million. Since these numbers were reported, we’ve noticed a considerable increase in chatter suggesting that Kemper may be in its final days.

Given the economic condition of Kemper and the potential for a liquidation proceeding, now is the time to review your files to determine if you have any claims or potential claims under any Kemper policies. Tyler's post concludes with this sound advice:

Given the limited recovery available in a liquidation, policyholders should evaluate whether such claims can be resolved now, even at discount. Kemp er may entertain such agreements since it could improve its balance sheet by removing reserves.  Thus, it is vital for policyholders to evaluate their risks in a Kemp er liquidation on a state-by-state basis and develop a strategy to mitigate those risks. We have done this for a number of clients and have been able to creatively reduce their exposure.

 

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Arbitration rules have increasingly come under scrutiny by various state legislatures and courts. Oftentimes changes in state arbitration laws intended for other parts of  the economy have found their way into the construction industry, with mixed results.  Last Friday Andrew Ness of Howrey LLP posted in the kluwerconstructionblog an insightful piece on a consumer protection bill recently proposed  in the House of Representatives.

 Rather suddenly, a substantial backlash against mandatory arbitration has appeared on the scene. One of the clearest indicators is the proposed Arbitration Fairness Act (H.R. 1020) that was introduced in the House of Representatives in February of 2009, and is still very much in play. While the anger is not directed at construction dispute arbitration, the concern is that commercial arbitration will end up being limited in important ways, as well as mandatory arbitration schemes where the use of arbitration is seen as one-sided and unfair.

The bill is intended to limit the reach of the Arbitration Act including the authority of arbitrators in situations where individuals are in unfair bargaining positions, e.g., employer-employee relations, personal credit issues, and individual real estate transactions. Mr. Ness expresses concern about the potential application of these limitations to the construction industry.

While the construction industry is not specifically targeted by the AFA, concerns have arisen that subcontractors and suppliers, for example, may attempt to claim unequal bargaining power when confronted with standard arbitration clauses contained in many form subcontracts. As a result, those concerned about cost effective and efficient dispute resolution in the construction industry, both within the U.S. and internationally, are following the AFA’s progress through Congress closely.

My thanks to Mr. Ness for making us aware of  the proposed Arbitration Fairness Act pending in Washington, D.C. and its potential impact on the construction industry. Arbitration provisions are bargained for rights in construction contracts.. They are intended to help parties resolve construction claims in an efficient manner. Legislation that potentially impacts contractual rights creates uncertainty which expands the risks associated with construction contracts. Therefore, I echo the warning of Mr. Ness's prescient post: those concerned with cost effective and efficient dispute resolution should follow this proposed legislation closely.

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Veteran Utah trial lawyer Harold G. Christensen recently published Samurai Lawyer, a pithy book that provides excellent counsel to trial lawyers based upon “The Samurai Way” of living (and dying, I might add). However, given the fact that more than ninety percent of civil cases settle before trial, it is negotiation skills, not trial skills, that are most often called upon by litigators, and yet relatively little attention is given to them 

 In Japan, samurai were warrior servants who embodied the law of bushido, a Japanese word formed from two other words: bukyo, meaning “The Warrior’s Creed,” and shido which means, “The Way of Gentlemen”. Litigators who adopt these principles to enhance their negotiating skills will resolve their clients’ disputes more effectively and will become more than courtroom warriors; they will be valued as wise and trusted counselors at law.

                                                           I. VISION

A successful negotiator has outstanding vision; he sees both the strengths and weaknesses of his case. He has the capacity to look beyond the narrow focus of advocacy and peer into the broad spectrum of possible outcomes through the eyes of the judge or the jury. He meticulously evaluates the law and facts advocated by his opponent, knowing, as did the samurai, that “You must understand the conditions on the opposite shore to comprehend your side of the river.” This perspective minimizes negotiating mistakes, which, studies have shown, occur more frequently with plaintiffs, but that when defendants do make them, they are really big mistakes resulting in awards much higher than plaintiff’s last pre-trial settlement offer.

                                                           II. PREPARATION

Samurai negotiators know “When you’re thirsty it’s too late to start thinking about digging a well,” so they prepare for the negotiations in every detail. Foundational questions include:

• What do I want to accomplish through the negotiation?
•  What outcomes would not be acceptable?
• Why would these outcomes not be acceptable?
• What are the terms that I must have vs. terms I would like to have?

In their seminal work, Getting to Yes,” Fisher and Ury suggested that negotiators prepare by determining their BATNA, their best alternative to a negotiated agreement. In other words, the client would rather  go to trial than accept an amount lower than the bottom number in her settlement range, if she is the plaintiff, or if she is the defendant, she would prefer going to trial rather than pay more than the highest number in her settlement range. In order to establish their BATNA, successful negotiators determine in advance the point at which the risks of trial outweigh the concessions their client must make to settle the case.

Trial risks can be effectively evaluated through decision tree analysis, in which the key events of the litigation through trial are projected, and an estimate of the probability for success or failure of these events is assigned. 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. If, on the other hand, the evaluation is limited to liability and damages, the basic question is what are the chances of prevailing on the issue of liability? If liability can be established, what is the range of damages likely to be awarded? The outcome will provide a range for settlement purposes.

                                                            III. Benevolence

“A wise man hears one and hears ten,” so goes the Japanese proverb. Litigators are not known for their benevolence in the courtroom; however, it is an important characteristic for negotiators, who must look beyond economics to see if there are additional motivating factors on the other side of the table. Successful negotiators consider the following:

• What are the conditions and circumstances of the other side?
• What is the financial condition of the other side?
• What business or personal pressures is the other side facing?
• What would my interests be if I were on the other side?

In addition, such things as the titles and responsibilities of the other side’s negotiating team, and their respective ages, length of employment, and relevant experience should be considered. But it does not stop there; successful negotiators also take into consideration the age, health, and financial condition of their clients, including the impact of the litigation on work and family, for successful negotiators understand that, win or lose, trials exact a price beyond money from all of its participants.

                                                             IV. WISDOM

Often, litigants negotiating a dispute will fall into the “You go first” trap. They want the other side to make the first offer and this often leads to frustration, mistrust, and, ultimately, an unsuccessful negotiation. Wise negotiators understand, “Knowledge without wisdom is a load of books on the back of an ass.” They recognize the psychological affects of anchoring and framing, concepts that inure to the benefit of the party who is willing to make the initial move during negotiations. Anchoring occurs when one of the parties makes the first reasonable settlement offer, one that suggests that the target figure is within reasonable range of the likely outcome if the case were to proceed to trial. Studies have shown that the party making the first reasonable offer will likely succeed in the negotiation as the other side must respond to the range that has been set.

Framing is a concept that gives the wise negotiator additional advantages by providing persuasive context to the negotiations. It can cause the other party to focus on features within a desired construct while disregarding other aspects arising from the disputed event. For example, in the realm of politics, we see national leaders framing the debate over health care. While one side has attempted to frame the debate by focusing on the importance of extending health care for everyone, the other side seems to have taken control of the debate by framing the issue as the nationalizing of health care for the benefit of a small group of uninsured people at great cost to the majority of Americans who are content with the status quo. As a result, the party in power has been put on the defensive and has been forced to react within the framework established by the “loyal opposition.” For the litigated case, framing is most effective during the initial phase of negotiations, either during pre-settlement correspondence, in mediation or settlement briefs or during a joint mediation session prior to caucusing. Thoughtfully done, framing can influence the subsequent behavior of both sides: for the “framer” it provides a pattern for organizing and shaping persuasive arguments, while placing on the other side the onus of responding within the desired framework.

                                                            V. HONESTY

Litigators may enlist many strategies during settlement negotiations: anchoring, framing, indifference, aggression, to name a few; but the samurai negotiator understands that honesty and integrity are perhaps the two most powerful tools available to him. He recognizes the truth of the Japanese proverb, which states, “Darkness reigns at the foot of the lighthouse.” Honesty can provide the light that engenders trust; trust will beget understanding; and understanding most often results in the resolution of a dispute, not because either side concedes it is wrong, but because of enlightened self-interest. Honesty also protects the negotiator who may be tempted to blur the line between “puffing” and deceit during negotiations. “ Indeed, cases from twenty-eight states hold that '[a]n attorney can be liable to a non client, even an adversary in litigation, for fraud or deceit.' " Shafer v. Berger Kahn, et.al. (2003) 107 Cal. App. 4^th 54. 

                                                            VI. LOYALTY

Hojo Shigetoki was a samurai warrior of the Kamakura period of the 13^th Century. His writings influenced generations of samurai who followed him. He said this about loyalty: “When one is serving officially or in the master's court, he should not think of a hundred or a thousand people, but should consider only the importance of the master.” Of course attorneys have the highest ethical obligations to their clients. Occasionally, however, clients may call into question the motivation of their attorneys during negotiations. In a recent case that cast into question the breadth of the mediation privilege in California, a client sued his lawyer for malpractice on the basis that the attorney forced him to settle the case. Cassell v. Superior Court, Cal App 4^th 2009/B215215. The samurai negotiator always places the interests of his client ahead of all other considerations.

                                                            VII. COURAGE

Some trial lawyers feel that settlement negotiations are for the faint of heart. Samurai negotiators understand this mentality. In fact they know there are certain cases that must go to trial, and they prepare for that possibility. But they also know that most of the time, lawsuits are resolved through negotiations, so they prepare themselves and their clients accordingly. This takes professional courage. Clients focused on justice do not always appreciate being told that a judge or jury may not agree with them. At the risk of offending or even losing their clients, samurai negotiators fully inform their clients of the realities of the case: that the costs of litigation may outweigh the upside potential of the damage award, that the judge may limit critical evidence, that the jury may not believe the expert witnesses, or any number of things that make ceding control of a case to a tribunal of strangers a very risky proposition. This leads samurai negotiators to engage in settlement negotiations prior to trial as forcefully and effectively as they would prosecute a trial, for they know, as the samurai knew, that “A good sword is the one left in its scabbard.”

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The 800 pound gorilla in every room of contractors or architects contemplating a design-build project is this: how do you pursue a design-build contract that may require some form of joint enterprise with other professionals and protect  your proprietary information at the same time?  Patrick Miller of Baker & Daniels  answers this and other related questions in an outstanding post about  drafting "teaming agreement," which includes the following nine points

1. Choose the Right Business Relationship. The team must figure out – before pursuing a contract with the owner – how it is going to come together. There are three basic options: limited liability companies, joint ventures, and subcontracts. As a general rule, if the plan is to pursue work in a given geographical area (like the State of Illinois), then an LLC is probably best. If it is to pursue a single project, then a joint venture or subcontract will work.

2. Understand the Owner's Contracts. Design-build calls for two parties to sign one agreement. AIA's version of Integrated Project Delivery calls for three parties to sign one agreement. Still another integrated delivery method – CM-At Risk – requires at least three parties to sign at least two agreements. In order to choose the best contractual relationship, the owner will need to consider the sector (public bidding laws may make all three options impossible), the market (a Chicago high rise office building may not be suitable for design-build), and the talent pool (if there are not any qualified design-builders in the immediate area, then once again, design-build may not be best). The teaming agreement should anticipate the proper contractual framework and assign responsibilities accordingly.
3. Put it in Writing. The biggest mistake your company can make in participating on an integrated team is to do it on a handshake. There is too much at stake, and you cannot leave basic terms undefined and important information unprotected (see items 4 through 9, below).
4. Make it Exclusive. If your company is putting forth the time and effort to pursue a project with other firms, it probably doesn't want to find out – after losing the contract – that two of its core team participants are on the winning team. Eliminate this risk by adding an exclusivity provision to your teaming agreement.
5. Make it Confidential. Participating on an integrated team will undoubtedly involve exchanging proprietary design and pricing information. If your company hands this over without restricting its use in a written agreement, then it is likely gone for good. Eliminate this risk by clearly establishing the confidentiality of such information and the penalties for disclosing it to outsiders, especially other teams.
6. Call Your Insurance Broker. With integration comes: 1) an evolving standard of care for the design community; and 2) potential design responsibility for the contractor. Does being part of the team void the architect's errors and omissions coverage? Is the owner unprotected if he or she doesn't have a contract with the architect? The answers are no, so long as the agreements and insurance are updated to accommodate the integrated project delivery model. Contact your insurance broker to confirm that your new arrangement has the proper coverage, and update your teaming agreement accordingly.
7. Check Your Licensing Laws. All states have laws defining what it means to practice "architecture" and "engineering." They also impose harsh penalties for offering to perform these services without a license. And some courts will void contracts where a party offers to perform these services without a license. Check these statutes, contact your State's licensing officials, and include language in your teaming agreement requiring the licensed professionals to be responsible for offering these services.
8. Identify the Team in the Agreement. The agreement should identify each team member and state the member's role: a) in pursuing the contract; and b) after the contract is won. Each identified member must sign the agreement.
9. Spell out the Scope, Time, and Cost. Pursuing design-build and other integrated projects is much more time consuming and expensive than simply negotiating a design contract or bidding on a set of construction drawings. The teaming agreement should contemplate these concerns by explaining the team's objective, how long it will take to meet the objective, and how costs in getting there are to be allocated. It should also deal with distributing stipend proceeds if the owner is offering a stipend.

There has been much written about the legal ramifications and risks associated with design-build contracts. Patrick's practical advice on the benefits of a teaming agreement and his nine points to consider before signing one add valuable insights to the discussion. Teaming agreements should  include provisions to give you the peace of mind to aggressively pursue the work while protecting your proprietary interests, trade secrets, and other competitive advantages.

Carefully drafted agreements are at the core of risk avoidance strategies. Many construction disputes are the result of ambiguous contract provisions or incomplete and unclear  plans and specifications. Ideally,  the design-build project delivery method minimizes conflicts between owners and contractors  by pairing the construction and design professionals on the same team and making them responsible for the design and construction of the project. Teaming agreements, on the other hand, can minimize the disputes that could otherwise arise between the architect and contractor if the terms of the joint enterprise are left unclear. Go team!

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The litigation arising from the construction of the Los Angeles Red Line subway described in Ari B. Bloomekatz' Los Angeles Times article,  "MTA's long legal battle draws fire" reads like a modern-day version of Charles Dickens' Bleak House, the story of the long and expensive probate litigation in England's Court of Chancery that wasted many lives and the fortune of the deceased benefactor. Mr. Bloomekatz reports that the litigation between The Metropolitan Transportation Authority and Tutor-Saliba, the general contractor, has lasted fifteen years and cost the public $34 million with no end in sight. Tutor-Saliba has paid about $25 million in litigation costs.

One thing is certain: the litigation costs of both sides far exceed their respective claims:Tutor-Saliba is seeking around $16 million and the most MTA can expect is about $15 million.

Even sophisticated parties like public agencies and national construction companies can lose sight of the goal-conflict resolution-when their aim is to be proved right. Conflict is a part of life, and it is inevitable in most construction projects to one degree or another. Therefore, the management of the conflict becomes an important part of managing the project. No project is truly complete until all disputes have been resolved.

Some simple tools of construction conflict resolution include:

• Don't take it personal. Even if the other side is making it personal, don't.
• To borrow from Stephen R. Covey's The 7 Habits of Highly Effective People, "Begin with the end in mind."
• Through contract or stipulation, establish efficient discovery procedures for effective and early evaluations.
• Remember the parties are in a better position to evaluate the dispute than 12 jurors, a judge, or an arbitration panel who will never understand the facts or the law as well as you do.
• Be realistic about your litigation costs. Like construction projects, litigation tends to cost more and take longer than originally planned.

Although the final chapters of the Red Line subway litigation saga have yet to be written, its impact will soon be felt by the very people the MTA is supposed to serve-public transportation users. The Times article reports:

With the agency now considering fare increases and service cuts, some officials are calling for an audit of the expenditures and wonder if the lawsuit represents a waste of taxpayer dollars.

Some people believe that certain disputes must go to trial, and in the Times article, MTA officials express their views on non-monetary reasons for pursuing the litigation. Nevertheless, the wisdom of a negotiated resolution which provides certainty while minimizing costs is illustrated by the 15 year $59 million Red Line subway litigation.

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A recent insurance case by the California Court of Appeal that denied insurance coverage to a contractor  Forecast Homes v. Steadfast Insurance Company (PDF), reminds me of the wisdom of this Japanese proverb: "When you’re thirsty it’s too late to start thinking about digging a well."  

It appears from the case that Forecast Homes followed standard procedure by getting its subs to name Forecast as a named additional insured in the subs' respective insurance policies prior to the start of construction. When sued for construction defects, Forecast tendered the claims to its subs' insurance company. The insurance company denied the claims and Forecast filed a declaratory relief action which, in essence, asked the court to declare that the insurance company was wrong in denying the claim.

The trial court found that the insurance company had acted properly because the policies had self-insured retentions that had to be paid by the subcontractors before the insurance company's obligations kicked in. Since the SIR limits had not been paid by the subcontractors, even though Forecast has paid defense costs that exceeded the SIR limits, the insurance company's did not have an obligation to defend and indemnify Forecast.

The proverbial wisdom contractors can learn from this case is this: "When a contractor is sued for construction defects caused by a subcontractor, it is too late to start thinking about coverage as a named additional insured on the sub's policy." 

Instead of simply filing the additional named insured certificate in the project file, it would be wise for contractors to spend some time asking questions about the scope and conditions of coverage under the terms of the subcontractors' policies.Even  though there are many other things that must be considered prior to construction, the benefits of fully understanding the actual insurance protection that is available will more than compensate for the time required for this risk avoidance exercises. It may also be prudent to include experienced construction insurance coverage counsel in this process.

My friend and construction insurance counselor Scott Turner of San Fransisco indicated that another avenue for the contractor to obtain insurance coverage under the facts of the Forecast case would be to file suit against the subcontrators for indemnity: " While not nearly as good as being an additional insured, the developer here may still have coverage of his indemnity claim against the insured sub." Scott is the author of Insurance Coverage of Construction Disputes (West Group 2nd ed. 2009).

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