On March 7, 2019 the U.S. Department of Labor announced a Notice of Proposed Rulemaking that could increase the minimum salary level for overtime-exempt employees. Currently, employees with an annual salary below $23,660 must be paid overtime if they work more than 40 hours per week. The new rule would increase that minimum amount to $35,308 per year. More information is available at www.dol.gov/whd/overtime2019.
Remember, however, that salary amount is only one component in determining whether an employee is exempt from the overtime requirement. To be exempt, an employee must also generally perform duties properly classified as executive, professional, or administrative.
Although the proposed rule is in its preliminary stages, employers should take note of the effect the rule could have on employees. In assessing its effect, employers should identify any employees who are classified as exempt and consider increasing salaries of those executive, administrative, and professional employees who may become eligible for overtime once the new rule takes effect. The costs of increasing some salaries may be less expensive than incurring the overtime costs. Similarly, should the salary level rise and make most of your team non-exempt, consider hiring more employees to spread the work around and avoid having fewer employees put in overtime hours.
By: Mike Cavosie & Betsy Huffman
The United States Department of Labor has announced plans to update the Fair Labor Standards Act regulations that set a salary threshold below which employees must be paid overtime. If this announcement sounds familiar, you are right; in 2016, the Department of Labor finalized a rule that would have required employers to pay overtime to salaried employees unless the employee made more than $913.00 per week or over $47,476.00 per year. However, the Obama-era increase never went into effect. It was blocked in November 2016 by a Texas federal court and is currently on appeal in the 5th Circuit.
Under the FLSA, employees must be paid at least 1.5 times their regular rate for any hours worked beyond 40 in a week, unless they are properly classified as exempt. Among other requirements, the FLSA’s administrative, executive and professional (white-collar) exemptions set a minimum salary that employees must earn. The current rule requires that salaried employees who are managers or those with certain “specialized skills”—such as a professional degree or training in a specific field, such as medicine—are exempt from the ability to earn overtime pay if they make more than $455.00 per week or over $23,660.00 per year. However, the Department of Labor has issued a Notice of Proposed Rulemaking, meaning they plan to develop a new rule regarding overtime pay. Specifically, the DOL plans to reevaluate the salary level for employees who are counted as “exempt” or unable to earn overtime pay.
The new rule could be announced as early as next month and although it is unclear exactly how the new rule will affect the salary threshold, employers should contemplate that raising the salary threshold could widen the pool of salaried workers who are eligible for overtime pay to include some employees classified as:
Executives—like project managers and VPs.
Professionals—such as licensed architects and engineers.
Administrative Employees—like accountants and marketers.
Bottom line: if you employ an individual who has previously been considered exempt from earning overtime pay, if the individual earns less than the salary threshold to be issued this year, then the employee may now be entitled to overtime.
Although the Department of Labor has not announced specifics, employers can prepare for the upcoming changes now. Employers should visit their employees’ current salary levels and ensure compliance with the federal rules. Additionally, employers should identify any employees who are classified as exempt and consider increasing salaries of those executive, administrative, and professional employees who may become eligible for overtime once the new rule takes effect. The costs of increasing some salaries may be less expensive than incurring the overtime costs. Similarly, should the salary level rise and make most of your team non-exempt, consider hiring more employees to spread the work around and avoid having fewer employees put in overtime hours.
No matter when the Department of Labor announces its new regulations, we will update you with the changes and explain what they might mean for you.
By: Betsy Huffman
Every 10 years or so, the American Institute of Architects updates its primary contracting forms. Years ending in a “7” are especially noteworthy because that is the year the AIA revises its most common forms, including the A201 “General Conditions of the Contract for Construction” (OK, there was the 1976 version, but all editions since have lined up with “lucky 7” – 1987, 1997, 2007, and now the 2017 version).
You are probably familiar with the A201. It is the most-used construction contracting form in the United States. The most recent version was released by the AIA in 2017, but a new edition normally takes 6-12 months to gain general market acceptance as everyone continues to use the prior edition as long as possible. (Most likely to avoid having to prepare a new, electronically-modified version of the form).
Well, that time is now. The 2017 edition of the A201 will become pretty much inaccessible starting October 1. That means that if you have not done so already, you need to plan to switch to the A201-2017 form very, very soon. And if you use a modified A201 – and that includes most developers and contractors – you need to get started now to make sure your new A201-2017 is ready to roll by October 1.
In addition to the A201, the most commonly-used AIA “Standard Forms” will also need to be revised. That includes the Owner-Contractor A101, A102, and A103, the Owner-Architect B101-2017, and the Contractor Subcontractor A401-2017.
It is particularly important to get started early with the 2017 forms because of one extremely-important change made to the forms: The insurance provisions have been taken out of the A201 and moved to their own exhibit. The new “Exhibit A Insurance and Bonds” has expanded significantly the insurance products and options available to the user, with more attention given to the scope, policy limits, and other terms of insurance. Now more than ever it is critical that your insurance program be reviewed by your insurer early and dovetailed with the new insurance Exhibit A.
It may still feel like summer, but fall is right around the corner so get started now!
By: J. Greg Easter
To quote the Indiana Supreme Court in a 2017 decision, “Indiana has a longstanding legal presumption . . . that spouses owning real property hold their interests as tenants by the entirety.” However, that presumption is rebuttable, and as the case of Cheryl Underwood v. Thomas Bunger, in His Capacity as the Personal Representative of Kenneth K. Kinney, et al., illustrates, the wording in the conveyance document is critical as to whether the presumption of the spouses’ ownership as tenants by the entireties will stand.
In Underwood, Cheryl Underwood, Kenneth Kinney and Judith Fulford, Kinney’s wife, acquired real property in Bloomington near the Indiana University Campus. The deed conveying the property granted title to “Cheryl L. Underwood, of legal age, and Kenneth Kinney and Judith M. Fulford, husband and wife, all as tenants-in-common.” When Kinney passed away, Underwood and Fulford remained owners of the property. Subsequently, Underwood’s former employer obtained a six-figure judgment against her and Kinney. The plaintiff holding the judgment sued to partition and sell the property and distribute the proceeds.
The deceased husband’s estate sought to dismiss the plaintiff’s action, arguing that the plaintiff’s claim should fail because it presupposes the deceased husband’s estate had an interest in the property. If the husband and wife held their interests in the property as tenants by the entireties, the husband’s interest would have passed to the wife upon his death, and the estate would no longer have any interest in the property.
Both the trial court and the Indiana Court of Appeals found that the deed conveying the property to the parties was clear and unambiguous in creating a tenancy by the entireties in the husband and wife. Accordingly, the marital unit (the husband and wife) was a tenant in common with Underwood, and when the husband’s interest in the property passed to his wife upon his death, the ownership in the property formerly held by the husband and wife was not subject to the judgment, which was rendered only against the husband and Underwood.
The Supreme Court first held that the deed was sufficiently clear to overcome the presumption that the husband and wife held the property as tenants by the entireties. It noted that any conveyance to spouses presumptively creates an estate by the entireties, but concluded that the granting clause indicating that the parties held the property “all as tenants-in-common” was sufficient to overcome the presumption that the conveyance to the spouses created such a tenancy by the entireties.
Specifically, the Court noted that the presumption is established under Indiana common law and also by an Indiana statute adopting the common-law presumption favoring a tenancy by the entireties when real property is conveyed to spouses. As quoted by the Court, the statute provides that “a contract shall not be construed as creating a tenancy in common unless it shall be expressed therein or shall manifestly appear from the tenor of the instrument that it was intended to create a tenancy in common.” The Court went on to note that the word “manifestly” was removed from the statute by a recent amendment.
The Court held that the presumption that the husband and wife held the property as tenants by the entirety was rebutted by finding that the phrase “all as tenants-in-common” was intended to create a tenancy in common among all of the grantees and not to treat the husband and wife as one entity taking title by the entireties. As a result, the husband’s interest in the property was also subject to the judgment, so that the wife lost the protections she otherwise would have enjoyed had she and her late husband held the property by the entireties, and only her remaining interest as a single tenant in common was insulated from the plaintiff’s judgment.
By George H. Abel, II
Indiana courts must shift attorneys’ fees to prevailing parties in mechanic’s-liens-foreclosure actions. Prior to the Indiana Supreme Court’s recent decision in Goodrich Quality Theaters, Inc. v. Fostcorp Heating and Cooling, Inc., 29 N.E.3d 124 (Ind. 2015), arguably only those with interests in the property could be liable for attorneys’ fees. After Goodrich, general contractors with no interest in the property may be required to pay foreclosing plaintiffs’ attorneys’ fees. Both general contractors and subcontractors must be aware of this decision and its potential consequences.
Goodrich Quality Theaters, Inc. leased property from Spirit Master Funding III, LLC (“Owner”) to construct a movie theater. Goodrich hired a general contractor (“General Contractor”) to oversee the project. General Contractor engaged several subcontractors (“Subs”) to provide labor, services, and materials necessary to construct the project.
Problems plagued the project, causing the theater to fall behind schedule. Owner failed to pay General Contractor the full contract price and, consequently, General Contractor did not pay Subs all payments owed. Subs timely filed mechanic’s liens against the property and sued Goodrich and Owner to foreclose on their respective liens. In the same action, Subs sued General Contractor, but only for breach of contract. The subcontracts did not permit fee shifting, but Subs requested attorneys’ fees by relying solely on Indiana Code section 32-28-3-14.
While the case was pending, General Contractor filed an undertaking and posted a surety bond under Indiana Code section 32-28-3-11. The bond obligated General Contractor, the bond’s principal, or its surety to pay any judgment recovered in a lien-foreclosure action, “including costs and attorney’s fees allowed by the court.” Approving the bond, the trial court released the mechanic’s liens, with the bond to serve as security in lieu of the property. Three months later, Owner paid General Contractor in full, and General Contractor and Owner filed a motion to dismiss the claims for attorney’s fees. The trial court denied the motion and ultimately awarded Subs their claimed amounts and attorneys’ fees. General Contractor appealed, challenging the trial court’s award of attorneys’ fees.
The Court of Appeals agreed with General Contractor, reasoning that Indiana’s mechanic’s lien fee-shifting provision only applies to property owners. The Supreme Court disagreed, holding that releasing the property in lieu of the bond did not discharge General Contractor’s obligation to pay Subs for their work. Rather, Subs’ liens subsequently attached to General Contractor’s stated obligation in the undertaking to pay the full amount of the judgment plus attorney’s fees and costs. In other words, the bond released and replaced the property as the liens’ security, and Subs became entitled to foreclose on the bond. This narrow holding makes sense. If it were otherwise, posting a bond would permit parties to circumvent the mechanic’s lien’s fee-shifting requirements.
But the case contains a potentially broader holding with likely unanticipated consequences. In arriving at its decision, the Court stated “even if [General Contractor] had not posted a bond . . ., the [Subs] still would have been entitled to recover attorney’s fees from [General Contractor] under § 32-28-3-14 . . . .” Id. at 665. It appears this is a result of the Supreme Court’s adoption of a misstatement of facts from the Court of Appeals’ decision. The Court of Appeals stated that the Subs named General Contractor in the foreclosure action because General Contractor held an interest in the property. And the Supreme Court alluded to the same fact in a footnote. But according to the parties’ briefing the General Contractor held no interest in the property and the Subs’ action against the General Contractor rested on breach of contract rather than mechanic’s lien foreclosure.
The general contractor’s property interest, or lack thereof, is critical because Indiana Code section 32-28-3-1 permits “[a] contractor, a subcontractor . . . [to] have a lien . . . on the interest of the owner of the lot or parcel of land.” While Indiana courts have interpreted “owner” broadly to include any person or entity holding a legal interest in the property, see Mid America Homes, Inc. v. Horn, 396 N.E.2d 879, 882 (Ind. 1979), General Contractor was not, and could not be, a party to the foreclosure action because it held no interest in the property. Instead, General Contractor was named in the lawsuit solely for purposes of the breach of contract count. In the absence of Indiana Code section 32-28-3-11, Subs would be precluded from recovering attorneys’ fees. Considering the facts of the case as disclosed in the parties’ briefs, the Goodrich decision may indicate that any person or entity can be liable for paying foreclosing plaintiffs’ attorneys’ fees, not just those who hold an interest in the property.
Both subcontractors and general contractors must be mindful of this development when assessing risks, negotiating their contracts, preparing bid packages, and deciding whether to pursue mechanic’s lien foreclosure actions. Goodrich is a win for subcontractors because it provides another potential avenue for fee shifting. Subcontractors should be mindful of this when reviewing contract remedy provisions. Though the subcontract may not contain a fee shifting provision, the subcontractor may be able to rely on Goodrich to obtain its fees so long as it names the general contractor in a breach of contract count in its foreclosure action against the property owner.
General contractors must likewise be mindful of Goodrich’s potential reach. Despite contractual provisions denying fee shifting, general contractors may be obligated to pay subcontractors’ attorneys’ fees when subcontractors file timely mechanic’s liens and name general contractors in the same action for breach of contract. Perhaps this provides additional motivation for general contractors to ensure that subcontractors are timely paid. On the other hand, when general contractors have no influence on owners to timely pay the contract price, they will face two choices: (1) pay subcontractors out of their own pocket to avoid paying attorneys’ fees later; or (2) defend foreclosure actions and seek indemnification from nonpaying owners for exposure to attorneys’ fees. To best protect themselves, general contractors need to ensure that their contracts with owners include specific indemnification language covering exposure for payment of subcontractors’ attorneys’ fees in foreclosure actions. Without this protective mechanism in place, general contractors may need to account for the potential for increased exposure to attorneys’ fees in their bid packages.
By: Charles B. Daugherty
Can the Property Manager of a Retail Center Be Liable For Injuries Resulting from the Acts of Intoxicated Customers?
The Indiana Court of Appeals recently decided a case involving premises liability in which the plaintiff sought to extend liability to the property manager of a retail center for injuries a customer suffered as a result of the acts of another intoxicated customer.
In Schneider v. Paragon Realty, LLC, the plaintiff had consumed five vodka drinks at her home and then accompanied her friend to Bubbaz Bar & Grill located in a strip mall owned by Heartland Landing II, LLC. She and her friend consumed additional drinks at Bubbaz and left the bar at 2:00 a.m.; her friend lost control of his car, and as a result of the crash, the plaintiff became a paraplegic. The blood alcohol content of the driver was .10.
The plaintiff filed suit against Bubbaz, Heartland and the property manager, Paragon, alleging (among other things) that (1) agents or employees of the defendants served the plaintiff and her friend alcoholic beverages with actual knowledge that they were intoxicated, (2) agents or employees of the defendants carelessly and negligently served the plaintiff and her friend alcoholic beverages when they knew or should have known that they were intoxicated and soon thereafter would be driving an automobile, (3) the defendants failed to adequately monitor and supervise their alcohol sales business activities, (4) the defendants and their agents or employees allowed the plaintiff and her friend to drive off, despite their obvious state of intoxication, (5) the defendants are responsible for the acts of their agents and employees under the doctrine of respondeat superior, and (6) the defendants are liable for the plaintiff’s injuries under the Indiana Dram Shop Act and a common law theory of premises liability.
Paragon moved for summary judgment alleging that it did not owe any duty of care to the plaintiff, and following a hearing, the trial court entered summary judgment in favor of Paragon. The plaintiff appealed, contending that Paragon owed her a duty of care because she was an invitee on the property owned, operated or controlled by Paragon. In support of that contention, the plaintiff designated evidence showing that the property management agreement between Paragon and Heartland gave Paragon the duty and obligation to maintain, operate, control and supervise the common areas, including the parking lot. The plaintiff alleged that Paragon should have known the plaintiff’s friend was too drunk to drive and should have stopped him from leaving the parking lot.
The Court of Appeals restated the general law for the plaintiff’s negligence claims: the essential elements for a negligence action are (1) a duty owed to the plaintiff by the defendant, (2) a breach of the duty, and (3) an injury proximately caused by the breach of that duty; whether a duty exists depends upon (1) the relationship between the parties, (2) the reasonable foreseeability of the harm to the person injured, and (3) public policy concerns. A landowner generally owes an invitee a duty to exercise reasonable care for her protection while she is on the landowner’s premises; the court recognized that this was an unusual premises liability case, because Paragon is not a “landowner” but a property management company hired by Heartland.
Paragon maintained that it had no control over Bubbaz’s premises or the events that led to the plaintiff’s injury. Paragon showed that its duties under the property management agreement were to: (1), collect rents and fees, (2) maintain the property in good condition and make repairs as necessary, (3) plan and manage capital improvements, (4) select and employ workmen for the maintenance of the property, (5) contract with utilities for the property, (6) pay taxes and mortgages, (7) deposit monies received on behalf of the owner, (8) negotiate lease agreements, and (9) render advice to the owner regarding property taxes and eminent domain. Accordingly, Paragon maintained that it did not owe any duty of care to the plaintiff to prevent the car accident that resulted in her injuries.
The Court stated that in premises liability cases, whether a duty is owed depends primarily upon whether the defendant was in control of the premises when the accident occurs. The defendant will be subjected to liability if that defendant could have known of any dangers on the land and could have acted to prevent foreseeable harm. The court noted that under the property management agreement, Paragon was a limited agent of Heartland, Bubbaz’s landlord. Paragon’s duties to Bubbaz’s customers were explicitly limited to maintaining the physical integrity of the common areas, and the court surmised that had the plaintiff tripped over uneven pavement in the parking lot and been injured, Paragon might have been liable. The Court of Appeals affirmed the trial court’s summary judgment in favor of Paragon finding that Paragon did not exercise any control over or have any responsibility for the way Heartland’s tenants conducted their business.
By George H. Abel, II
A recent decision by the Indiana Court of Appeals involving trespass by one property owner and negligence by another (which resulted in damages from surface water drainage) led to a split decision for the parties who had been granted a significant monetary award. In Liter’s of Indiana, Inc. v. Earl E. Bennett and Daniel Bodine, Liter’s developed its property for a residential subdivision in Jefferson County, Indiana, and Bennett and Bodine owned property adjoining the subdivision. In the course of developing the subdivision, Liter’s discovered that the eaves of the home located on the Bennett and Bodine property and a driveway serving the home encroached upon the Liter’s property. In order to provide drainage for the subdivision, Liter’s requested an easement from Bennett and Bodine to construct a storm water detention basin on their property; in exchange, Liter’s would grant them an easement so the encroachments could remain. Bennett and Bodine rejected the request, and Liter’s erected a chain link fence on the property line between its property and the adjoining property, in very close proximity to the home.
Liter’s filed a lawsuit seeking to enjoin the trespass onto its property in connection with the encroachments and to recover damages. Bennett and Bodine filed a counterclaim contending that the fence constituted a nuisance and that Liter’s had negligently designed its subdivision, resulting in surface water from the development flooding their property.
A jury trial was held on the trespass, nuisance and negligence claims. An expert witness retained by Bennett and Bodine testified that, based on calculations that he would have used, the detention basin was too small, resulting in storm water being released from the detention basin at a faster rate; this caused erosion and flooding on the adjoining property. Liter’s expert witness contradicted that evidence and testified that he had inspected the detention basin and had determined that it was adequate for the subdivision being constructed. Bodine testified that after Liter’s drainage facilities were constructed and development of the subdivision begun, storm water drained across their property, resulting in erosion underneath their driveway and water ponding against the exterior walls of the home. A licensed appraiser testified that if such flooding occurred three times a year, Bennett and Bodine would suffer damages in the amount of $134,500.00 as a result of the devaluation of the home.
In addition to testimony designed to contradict the testimony of the expert retained by Bennett and Bodine that the drainage facilities were inadequate, Liter’s sought to rely on the “common enemy” doctrine applied to surface water drainage. The common enemy doctrine provides that surface water which does not flow in defined channels is a common enemy, and each landowner may deal with the water in any manner that best suits its needs; accordingly, it is not unlawful for a landowner to improve its property in a way that accelerates the flow of surface water by limiting ground absorption or changing the grade of the land. However, there is an exception to the common enemy doctrine where a landowner, by artificial means, collects storm water and casts into onto a neighbor’s property. The jury negotiated for nine hours and awarded $51,150 each to Bennett and Bodine for damages resulting from the devaluation of their property due to flooding; the Indiana Court of Appeals found that the jury had properly considered the evidence and reasonably determined that, under the exception to the common enemy doctrine, Liter’s undersized detention basin led to casting water onto the adjoining property, supporting the award for the negligence damages.
The fence had been removed, and while the jury found for Bennett on Bodine on their nuisance claim, it awarded no damages. The jury also found in favor of Liter’s on its trespass claim but awarded no damages. At trial, Liter’s presented evidence that its property had been devalued by $18,000.00 as a result of the trespass by the adjoining property owner. The Court of Appeals upheld the jury’s decision to not award any damages to Liter’s, noting that it can only consider the evidence that supports the award; because appellate courts are unable to actually look into the minds of the jurors, the courts will not reverse an award if it falls within the evidence. The Court presumed that the jury followed the court’s instructions that it could award damages and then determined that Liter’s was not entitled to any such damages, even though a trespass existed. However, the Court also found that, since the eaves of the home still extended over the Liter’s property, Liter’s was entitled to a permanent injunction requiring Bennett and Bodine to remove the portion of the roof that extended over the Liter’s property. Accordingly, while Bennett and Bodine did receive a substantial monetary award, they will end up spending at least a portion of that amount to alter the home on their property to remove the portion of the roof extending onto the Liter’s property.
By George H. Abel, II
By: Charles B. Daugherty
Insurance companies are in the business of assessing risk and compensating insureds when the unexpected arises, but payment is not necessarily the last step in the claim process. As a general rule, upon payment of a loss, an insurer may step into its insured’s shoes and assert any right of action which the insured may have against a third person whose negligence or wrongful act caused the loss. This is the definition of subrogation. Subrogation is an instrument of economic efficiency because it forces negligent actors to bear the costs of their actions, which avoids externalities—the imposition of an activity’s costs upon others. When subrogation is precluded, externalities result because innocent actors bear the costs associated with the negligence of others.
The subrogation concept applies across many types of loss in many industries, including the construction industry. Subrogation in the construction context, however, is unique. Construction projects are complex endeavors. This complexity has posed a dilemma for many courts. Subrogation lawsuits delay valuable construction projects and result in costly and lengthy litigation. Commentators have noted that “in the construction setting, [an insurer’s subrogation action and] recovery can frustrate the intention of the participants and the participants’ insurers.”Consumers ultimately suffer from (1) delayed use of new facilities and (2) increased costs passed on by construction litigants. In response to this, many construction contracts, including the AIA’s standard forms, include subrogation-waiver clauses.
But precluding subrogation leads to externalities and economic inefficiency because negligent parties are not forced to bear the loss arising from their own negligence. These costs too are ultimately shouldered by the consumer. Like many states, Indiana has also grappled with these conflicting policies. Over the years, Indiana’s courts have upheld waivers of subrogation in the construction industry. Along the way, the subrogation-waiver landscape has been shaped by several construction disputes.
In its most recent announcement on the topic, Indiana’s Supreme Court took an expansive approach to subrogation-waiver clauses by holding that, under the language at issue, an insurer was precluded from recovering for losses to both “work” and “non-work” property. This short article Teton’s impact on the construction industry.
Teton and Its Impact
The Indiana Court of Appeals has addressed a “work” versus “non-work” distinction that has divided courts across the United States. Until this year, the Indiana Supreme Court had not weighted in on the issue. Teton changed that.
In 2004, the Indiana Court of Appeals adopted the “minority approach” by holding that subrogation waivers in standard AIA agreements are only effective to waive damages sustained to property that is subject to work under the contract, even if an insurance policy covers damages to other non-work property. But, in 2014, a different circuit adopted the “majority approach” by holding that subrogation waivers in standard AIA agreements are effective to waive damages sustained to any property covered by insurance, whether property that is subject to work under the contract or other non-work property. The Indiana Supreme Court granted transfer to address the split between the circuits
Teton arose out of a renovation and remodeling project at the Jefferson County courthouse. The first phase of the project involved repairs to the courthouse roof, flashing, gutters, and downspouts at a price of $87,280.00. The parties’ contract required Jefferson County to obtain separate property or builder’s risk insurance for the project.Instead, Jefferson County relied on its existing property insurance. The construction contract contained the following language:
11.3.5 If during the Project construction period the Owner insures properties, real or personal or both, adjoining or adjacent to the site by property insurance under policies separate from those insuring the Project, or if after final payment property insurance is to be provided on the completed Project through a policy or policies other than those insuring the Project during the construction period, the Owner shall waive all rights in accordance with the terms of Subparagraph 11.3.7 for damages caused by fire or other perils covered by this separate property insurance. All separate policies shall provide this waiver of subrogation by endorsement or otherwise.
11.3.7 Waivers of Subrogation. The Owner and Contractor waive all rights against . . . each other and any of their subcontractors, sub-subcontractors, agents and employees, each of the other . . . for damages caused by fire or other perils to the extent covered by property insurance obtained pursuant to this Paragraph 11.3 or other property insurance applicable to the Work . . . .
During construction, a roofing subcontractor allegedly caused a fire while soldering downspouts near the courthouse’s wood frame. The fire resulted in approximately $6 million in damages. Jefferson County filed a lawsuit against the contractor and its subcontractors. The contractor raised the waiver of subrogation clause as a defense, but Jefferson County argued that the waiver only applied to damages to the “Work,” as defined in the contract, meaning that Jefferson County should not be precluded from recovering damages exceeding $87,280.00 contract price for the renovation work.
The Indiana Court of Appeals held that Jefferson County waived its right to subrogate all damages claims covered by its property insurance, including damage to “non-Work” property. Noting that the majority approach furthers the underlying purposes of subrogation waivers by “avoid[ing] the predictable litigation over liability issues and whether the claimed loss was damage to Work or non-Work property,” the court applied the waiver of subrogation provision to all of Jefferson County’s property covered by property insurance. Jefferson County, therefore, could not recover.
On transfer, in a case of first impression, the Indiana Supreme Court affirmed the Court of Appeals and adopted the majority approach. The Court reasoned that “[t]he positioning and plain meaning of the word ‘covered’ restricts the scope of the subrogation waiver based on the source and extent of the property insurance coverage, not the nature of the damages or of the damaged property.”The Court held that “if property damages (of any sort) are “covered” by an insurance policy . . . , the waiver applies.”
Teton will impact construction-project participants, the insurance industry, and, ultimately, consumers. Teton, like cases before it, runs counter to classic economics’ externality aversion by placing the loss on an insurance company whose insured did not cause the loss. After Teton, those externalities are potentially greater because unrecoverable losses can extend beyond the price of the construction contract. What does this mean for the construction industry?
Construction is a contract-driven industry. Drafters are free to modify standard-contract insurance language in attempt to avoid Teton’s result. If the parties intend to restrict the scope of waivers to the value of the construction contract, they can presumably do so. But what incentive have they to take those steps? After all, the reason for laying the loss on insurance companies is to avoid time-consuming litigation and resultant project disruptions. Who is bearing this increased cost? Insurance companies are profit-seeking enterprises. When their exposure increases, premiums increase. Owners and contractors are also profit-seeking entities. When their insurance premiums increase, they attempt to pass the increased cost on to the ultimate users of their products and services. The consumer, therefore, ultimately pays a higher price for the same goods and services, despite playing no role in the negligent actions causing loss. This was true before Teton, but the recent decision appears to have increased that tax.
Teton teaches that Indiana, like the majority of states considering the issue, has determined that the costs to construction participants, the insurance industry, and, ultimately, consumers resulting from construction-project subrogation actions outweighs even the post-Teton era’s increased externalities resulting from shifting unrecoverable loss to insurers. Only time will tell if construction participants, as reflected by their contracts, will agree with this valuation.
A “flow-down” clause provides that a subcontractor assumes toward the builder all the duties and obligations the builder has assumed toward the homeowner. Flow-down clauses can create a number of problems. If the clause is interpreted broadly, the subcontractor may have agreed to build the entire home. If the intent of the clause is to impose on the subcontractor only the technical requirements of the contract that apply to the subcontractor’s scope of work, an overly-broad flow-down clause obviously will not accomplish this intent.
In a Nevada case, a contract clause stated that the risk of loss of completed work remained with the builder until final acceptance by the project owner. The clause was incorporated into a subcontract by a flow-down clause. The subcontractor ultimately bore the risk of loss until final acceptance of the home.
And in a Washington State case, a prime contract required the builder to name the owner as an additional insured on the builder’s liability policy. The court held that a general flow-down clause did not impose this obligation on a subcontractor since it was not sufficiently precise to put the subcontractor on notice that this was required.
A few Indiana courts have interpreted flow-down clauses, often with mixed results. In one Indiana case, a contract required the builder to provide the owner with lien waivers prior to receiving payment. The subcontract contained no such requirement, but a flow-down clause incorporated the lien waiver requirement into the subcontract. The lien waiver was held to be a necessary condition to the subcontractor’s right to get paid.
In a 2002 case, the court considered the standard flow-down clause contained in the contract forms promulgated by the American Institute of Architects. The court noted that “a flow through provision is intended to incorporate into the subcontract the provisions of the prime contract which related to the subcontractor’s performance.” The court found that an acceleration claim submitted by the subcontractor was barred by the failure to provide written notice of the claim within the time required by the contract between the owner and builder.
Conversely, the court refused to flow-down for the benefit of a subcontractor a preferential interest rate contained in the prime contract in a 2002 Indiana case. The court determined that the flow-down clause only pertained to the “work” provisions of the prime contract applicable to the subcontractor “and as such do not include the payment provisions” of the prime contract. The court also recognized “a public policy interest in allowing subcontractors to negotiate a price without being constrained by the contractor and owner’s negotiated price and method of payment.”
By: J. Greg Easter
Construction contracts come in all shapes and sizes. For commercial projects, the parties often use pre-printed contract forms such as forms promulgated by the American Institute of Architects, the Associated General Contractors, and the Engineer’s Joint Contract Documents Committee. However, there are few generally-accepted contract forms applicable to residential projects, although pre-printed forms used for commercial projects may be modified for use on some residential projects. They may be particularly appropriate for large or complex residential projects.
Most residential contracts are “customized” forms drafted by the attorney for a party. Many disputes have arisen as a result of the failure of the builder to include in the contract all of the essential terms of the transaction or to express the intentions of the parties in clear terms. Other disputes have originated from the failure of the builder to incorporate by reference the plans and specifications that govern the technical aspects of the builder’s work or other documents that were intended to be a part of the deal.
That leads me to Rule #1: All construction contracts should incorporate by reference a set of plans and specifications prepared by an architect, engineer or designer. Where the plans and specifications are incorporated by reference, the builder is bound to comply with the requirements of the plans and specifications. And when the builder strictly complies with the requirements of the plans and specifications, the builder will not be liable for the consequences of defects in the plans and specifications.
Under the doctrine of “incorporation by references”, a separate document may become a binding part of a construction contract by virtue of an express reference to that document in the contract. It is not necessary to attach the incorporated document to the contract, but the referenced document must be in existence and must be reasonably described.
An example: “The Builder shall perform the Work in accordance with the plans and specifications identified in Schedule 1 to this contract.” By referring to the Schedule 1 plans and specifications, and then attaching that Schedule 1 to the contract at the time the contract is signed, the plans and specifications are considered by the law to be as much a part of the contract as if they were physically reproduced in the body of the contract.
By J. Greg Easter