Contract Documents of the Design-Build Institute of America
May 2002
Kent Holland examines a few of the more significant
clauses of the DBIA standard forms affecting risk allocation and potential insurance
coverage.
by J.
Kent Holland Jr.
Arch Insurance
Group Inc.
Obtaining reasonable terms and conditions in contract documents is one of
the most vital elements of risk management for the design professional and other
parties to a construction project. The age-old question is: "What is reasonable?"
Some would argue that just as beauty is the eye of the beholder, an opinion
concerning whether contract language is reasonable will depend on which party
to the contract you ask. For this reason, contracts drafted by project owners
may tend to favor the owner by allocating or shifting risk to the design professional
or contractor. Likewise, contracts drafted by individual design professional
firms may have a tendency to favor the designer.
In contrast, professional associations such as the American Institute of
Architects (AIA), Engineer's Joint Contract Documents Committee (EJCDC), and
the Association of General Contractors of America (AGC) have endeavored to produce
standard form contracts acceptable to all parties to the agreement. In drafting
these contracts, multiple entities and associations with an interest in construction
have been consulted and had input in creating documents that strive to maintain
a reasonable allocation of risk. Reasonable risk allocation occurs when the
contract allocates responsibilities and risks to the party in the best legal
and practical position to manage the risk through its own actions.
One goal of the associations is to encourage the various project participants
to use standard form agreements to the greatest extent possible, even if this
means sometimes adding an addendum revising a few of the terms and conditions
to accommodate the requirements of particular firms and their insurers. Using
standard forms goes a long way toward eliminating confusion and ambiguity over
the intent and application of the language. After a contract clause has been
interpreted and applied in different fact situations by courts around the country,
parties using the form in the future have a pretty good idea of what the language
means and what they are agreeing to when they sign such a standard form agreement.
Using these contracts can save time during contract negotiation and give greater
certainty to the outcome of potential claim issues that might arise under the
contract.
With the advent of design-build construction, the various professional associations
concluded that there was a need for new forms to address this mode of construction.
None of the contract forms had previously dealt specifically this type of project
delivery system. Each of the associations listed above have issued design-build
contract forms in the past several years. Each has its own unique way of addressing
issues. Of the forms currently available, those drafted by the Design Build
Institute of America (DBIA) in 1998 appear to be receiving the most favorable
review. The forms are well organized, easy to follow and understand, and, with
a few exceptions, provide an allocation of risks between the parties that appears
to be reasonable. Since space does not permit a discussion of everything contained
in the forms, this article will focus only a few of the more significant clauses
impacting risk allocation and affecting potential insurance coverage.
The terms and conditions referenced herein are from DBIA forms 520, 525,
530, and 535. Rather than guiding the reader to the specific form where a clause
may be found, reference will be made to the "DBIA form" throughout this article,
with the understanding that there are slight differences in how each form addresses
the specific issue. Before using any of these forms, the reader and reader's
attorney will need to become familiar with the specific provisions of each,
and it advisable to seek guidance from insurance professionals concerning how
the language may impact coverage under applicable insurance policies.
Ownership of Documents
The design-builder owns the work product of its design efforts. The project
owner is granted a limited license, giving it use of the documents under certain
specified circumstances. In consideration of this license, the owner compensates
the design-builder with a premium over its initial compensation in the event
that the owner terminates the design-builder and continues the project with
another design-builder. From a risk management prospective, one of the most
important features of this clause is that the owner agrees to indemnify the
design-builder and its architect/engineer (A/E) form damages arising out of
the use of the documents.
The owner does not have the contractual right to use the design as a prototype
for other projects. This limitation is important for several reasons. From a
business perspective, it assures the design-builder that it is not giving away
a design for a small fee on one project only to see that design used on numerous
other projects constructed by the owner—with no further involvement of the design-builder
or fee being paid to the design-builder. From a risk management perspective,
this avoids a manageable risk on one project becoming unmanageable and uncompensated
as it expands to potential liability for claims arising out of multiple future
projects that are built without the design-builder's knowledge or involvement.
Changes
The owner may make reasonable changes to the project. "Change orders" are
used when the parties can agree on the adjustment to price and time to perform
the work. "Work change directives" are used by the owner to direct a change
when the parties agree that there is a change but have not yet agreed on the
adjustment of time and price resulting from that change. In addition, the design-builder
can make "minor changes" in the construction documents, provided it gives notice
to the owner and there is no material and adverse affect on the work, and there
is no effect on price and time.
A feature of this clause that should enhance amicable performance of work
while a decision on equitable adjustment is pending is that if the owner directs
the design-builder to perform disputed work, the owner is required to pay 50
percent of the reasonable estimated direct cost of performance while the matter
is pending resolution. The contract requires the parties to negotiate the disputed
issue expeditiously and establishes that if resolution cannot be reached, the
parties will resort to the dispute process designated in the contract.
Too often on large projects, design-builders or A/Es get behind in their
compensation from the owner because of unresolved differences of opinion concerning
whether service is "additional service" or is part of the "basic service" that
is already compensated under the "basic fee" or "guaranteed maximum price."
When this happens, parties can quickly become adversarial instead of working
together for the good of the project. With financial difficulties caused by
cash flow problems, genuine problems with the project can develop as result.
If at the conclusion of a project the owner still owes significant sums to
the design/builder or A/E as the result of unresolved differences of opinion
over payment, the design-builder may be inclined to sue its client for the balance
it believes to be outstanding. In the context of standard A/E contracts, this
has inevitably led to counter-suit against the A/E by the owner. This is the
kind of situation the DBIA contract language seeks to avoid.
Hazardous Conditions
If conditions related to preexisting hazardous conditions are encountered
at the site, the design-builder is to stop work and notify the owner of the
situation. It is then the owner's obligation to take the necessary action to
remedy the situation. This may include getting a qualified expert to assess
the site and prescribe remediation measures to be carried out by the owner.
The design-builder is to be compensated for the impact to its time and price
caused by the delay from the hazardous condition. It is also to be indemnified
by the owner for claims or damages arising out of the presence, removal, or
remediation of hazardous conditions. If a hazardous condition is created by
the design-builder bringing hazardous materials to the site, the design-builder
is required to indemnify the owner for claims and damages arising from that
condition.
Standard of Care and Warranties
Since the design-builder is responsible to the owner for both the design
and the construction of the project, it becomes somewhat more difficult to segregate
the design services from the construction work, and to create separate contractual
obligations as to the standard of care and responsibility for these separate
components. Other standard design-build contracting forms (AIA, AGC, and EJCDC)
state that the design services will meet the generally accepted standard of
care (i.e., they will not be negligently performed). Warranties for the construction
work, including materials and workmanship, are provided for separately. The
DBIA documents do not create different standards for the design and construction
aspects of the project. In recognition of the fact that many owners will be
using performance-based specifications requiring the design-builder to devise
its own design for meeting the specified performance requirements, the DBIA
documents provide that where performance requirements are specified, the design-builder
is to meet the standard of care necessary to provide design services achieving
the agreed upon performance standards.
It appears that under the DBIA documents for projects involving performance
guarantees, the design-builder warrants both its work as well as its design.
For a 1-year period from the date of substantial completion of construction,
the design-builder warrants to correct any work. "Work" is defined to include
design as well as construction. From a professional liability standpoint, this
clause has the potential to create an uninsurable loss, since errors and omissions
coverage for design professionals covers only those losses caused by the negligent
performance of professional services by the design professional. In this regard,
the language of the AGC and EJCDC documents specifying that only the construction
work is included in the warranty for correction is preferable.
Indemnity
In addition to requiring the design-builder to indemnify the owner for claims
arising out of bodily injury and property damage to the extent they arise out
of the design-builder's negligent performance, the DBIA documents require the
design-builder to "defend" the owner from claims. The owner is not required
to indemnify the design-builder for damages arising out of its own negligence,
but is required to indemnify to the extent that damages arise out of the negligence
of other contractors separately engaged by the owner.
The provision requiring the design-builder to provide "defense" for the owner
is ill advised from a risk management and insurance perspective. The costs incurred
by the design-builder in defending the owner against a claim are not covered
by errors and omissions insurance of the design professional. Such an agreement
creates what is known as "contractual liability" for damages that would not
otherwise be awarded by a court in the absence of the contract. Such damages
are expressly excluded in professional liability policies.
Right To Stop Work
Certain actions by the owner will entitle the design-builder to stop its
work and terminate the agreement based on the owner's default. Short of asserting
that the owner is in default, the design-builder may nevertheless stop work
if the owner fails to provide financial assurances required by the contract
or make payments that are due and payable. In such an event, the design-builder
is required to give 7-day notice to the owner, after which it may stop work.
In addition, the design-builder may terminate the agreement for default if the
work has been stopped for 60 consecutive days, or for 90 days over the life
of the project, due to (1) the owner's suspension of work, court order, or other
governmental authority; (2) owner's failure to provide needed information, permits
or approvals; or (3) owner's failure to provide required financial assurances
or make timely payments as required by the contract.
This is a valuable provision because, for the reasons above concerning the
"changes" clause of the contract, it is important that the design-builder obtain
this type of contractual protection against having to perform extended services
without compensation and without the ability to terminate.
Dispute Resolution
The dispute resolution process consists of a five step process, including:
- Submit written notice of claim with 21 days after the events giving
rise to the claim.
- Discuss the issues between the parties "at the field level."
- Hold a meeting with the senior representatives of the parties within
30 days following the failure of step (2) to resolve the disagreement.
- Submit the matter to nonbinding mediation.
- Submit dispute that could not be resolved in mediation to binding arbitration,
with the prevailing party in the arbitration being entitled to recover its
attorneys' fees and expenses from the other party.
Steps one through four are commendable. With regard to the final step, however,
it is preferable that the contract leave it to the parties to decide at the
conclusion of step four what forum to use for final binding resolution of the
claim. Litigation may be preferable to arbitration and may in some instances
lead to more prompt results. In complex construction disputes (particularly
large design-build projects), litigation allowing discovery of documents and
deposition testimony may be critical to ascertaining the facts and liability.
On the other hand, for disputes that will be decided in foreign jurisdictions,
it may be more prudent to have the matter resolved by independent arbitrators
than by a court.
Some professional liability insurers are adverse to parties agreeing by contract
to have disputes resolved by binding arbitration. This is because the lack of
a decision by arbitrators explaining the factually and legal basis for their
decision may render it impossible for the insurer to determine whether an award
against the insured arises out of insurable causes and damages.
Consider, for example, a case in which there are multiple claims against
an A/E, for example, based alleged breach of contract, breach of warranty, breach
of guarantee, negligent performance, intentional misrepresentation, and willful
misconduct. If, without explanation, an arbitrator splits the baby in the middle—as
they so often do—and awards half the damages alleged by the owner against the
A/E, the insurer may be unable to ascertain whether the award is for damages
that are insured under the policy.
In the hypothetical claim presented above, several of the causes of action
(including, warranty, guarantees, and willful misconduct) are uninsurable. With
an unexplained arbitration award, an insurer might conclude that the award was
based on breach of warranty and guarantees that are expressly excluded under
the errors and omissions policy. In my opinion, arbitration should not be used
as a dispute resolution process without prior authorization from the insurance
company and without a contractual commitment of the arbitrators to render a
detailed decision analyzing the facts and the legal basis for the decision.
Conclusion
The DBIA standard forms offer a reasonable starting point from which to negotiate
contracts for design-build projects. When using the forms, the parties should
seek the advice of legal counsel and insurance professionals in order to amend
several clauses to facilitate the insurability of potential losses.
Opinions expressed in Expert Commentary articles are those of the author and are
not necessarily held by the author’s employer or IRMI. This article does not purport
to provide legal, accounting, or other professional advice or opinion. If such advice
is needed, consult with your attorney, accountant, or other qualified adviser.