Kent Holland examines a few of the more significant clauses of the DBIA standard forms affecting risk allocation and potential insurance coverage.
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.
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.
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.
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.
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.
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.