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

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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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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