Organization Best Defense in Handling Construction Defect Claims

Subrogation, indemnity, and legal issues are important factors when dealing with construction defect (CD) claims. Because these issues arise concurrently, it’s essential that adjusters stay organized when handling CD claims, according to Lynne Jurek Shannon and Doris T. Bobadilla, construction attorneys with the law firm of Galloway, Johnson, Tompkins, Burr & Smith.

Shannon and Bobadilla presented a seminar on the subject in Minneapolis, Minn., earlier this year. During the presentation they offered an organizational checklist to remind adjusters what issues need to be addressed and/or resolved during a CD claim:

1) Pre-litigation considerations;

2) Common theories of liability;

3) Examine validity of claim;

4) Retain experts to assess work of all parties involved;

5) Locate additional parties to assist in defense cost;

6) Indemnity analysis;

7) Secure scene and relevant evidence for subrogation purposes

Pre-Litigation Considerations

According to their presentation, pre-litigation issues include determining the cause of the alleged defect; determining the nature of the defect, and determining whether the defect is the apparent result of construction, the design or both.

Examining the nature and potential cause of the defect can help to address possible claims against an architect or engineer. In addition, warranty, insurance and performance bond issues need to be considered early on, Shannon and Bobadilla said.

Common Theories of Liability

According to the experts, common theories of liability contained within CD lawsuits include breach of contract, quantum meruit, breach of warranty, negligence, negligent misrepresentation, fraud/fraud inducement and indemnity.

A breach of contract claim, according to the presenters, may serve as the basis for a CD lawsuit. Contract claims permit the prevailing party the opportunity to seek attorneys’ fees and court costs. The elements of breach of contract include a valid enforceable contract, plaintiff’s right to sue, and a breach of the contract resulting in damages recoverable under the contract due to the breach.

Quantum meruit, also known as unjust enrichment, can be pled as an alternative theory to breach of contract in order to address less than full and complete performance, as well as for work beyond the scope of the contract, the presenters said.

Shannon and Bobadilla defined a warranty as an independent promise apart from the contractual obligations of the lease or sale contract. A breach of an express warranty is considered a breach of contract claim, whereas breach of implied warranty causes by an operation of law is considered a tort, they said.

While express warranties may be set forth in the construction contract, there are usually no express warranties in a design contract, the attorneys said. The warranties may cover goods and services. An express warranty may be contained in the construction contract and/or in an agreement from a third party warranty company.

According to Shannon and Bobadilla, under a negligence theory a plaintiff has to establish three elements: the defendant owed a legal duty to the plaintiff; the defendant breached the duty; and the breach proximately caused the plaintiff’s injury.

Negligent misrepresentation is a business-related tort. An action for negligent misrepresentation applies only when the defendant has a financial interest in the transaction in which the information is given.

Common-law fraud and fraudulent inducement are not common causes of action in CD cases, according to the presenters. When warranted, a claimant will assert fraud claims as another means to recover exemplary damages. In order for a fraud cause of action to be included within the complaint the defendant must have knowingly made a material misrepresentation to the plaintiff that he or she knew would be acted upon in reliance by the plaintiff and the plaintiff sustained damages as a result.

Common law indemnity is limited to situations where liability is vicarious or claims are made by innocent retailers in products liability cases, the presenters said.

Evaluating the Validity of a CD Claim

Evaluating the validity of a CD claim starts with determining if the claims alleged are barred by the appropriate state’s statute of limitations or statute of repose, Shannon and Bobadilla said. For contractors, architects, engineers and designers it is generally 10 years from substantial completion of improvement or date the equipment which is attached to the real property begins to operate.

The timeline to file claims for general products liability, negligence, negligent misrepresentation, and claims against manufacturers will vary, according to the attorneys.

In the event that multiple subcontractors are responsible for the construction of different parts of a project, the statute of repose applies to each subcontractor only for the portion of the project that the subcontractor completed, they said. Generally, statutes of repose do not bar an action based on willful misconduct or fraudulent concealment in connection with the performance of the construction or repair.

Experts Retained to Evaluate Merits of a Claim

Once they have determined that a CD claim isn’t barred by the statute of limitations or repose and is covered under a policy, adjusters should estimate each party’s potential liability to evaluate the merits of the claim, according to Shannon and Bobadilla. They said this is the time to retain appropriate experts who can define what it will take to repair the damage and at what cost. The adjuster should also consider hiring a qualified attorney to help guide the process.

They recommended hiring a construction expert at the earliest stage of the investigation.

Indemnity Analysis Key to Spreading Risk

CD lawsuits center upon claims by the contractor or developer against the subcontractors for defense and indemnity pursuant to the terms of the subcontract agreement.

Shannon and Bobadilla define indemnity as “a contract whereby a party, called the indemnitor, agrees to protect another, called the indemnitee, against damages incurred by the latter as a result of his breach of a duty owed to a third party.”

The purpose of indemnity is to allocate risk and shift the risk of loss from the indemnitee to the indemnitor regarding liability to a third party incurred by the indemnitee in the course of his contractual performance, they said.

The presenters recommended adjusters send written notice of the intent to seek indemnity to all potential sources of indemnity after having an attorney review the hold harmless language for validity.

Bobadilla referred to the case of Fontenot v. Chevron U.S.A. Inc., in which the court found that the indemnification clause and the waiver of subrogation clause, when used together, fit hand in glove. “They offer two distinct advantages to…a company contracting with a…contractor,” the court said. “The indemnification clause allows the company to shift liability to the contractor. The waiver of subrogation supplements this shifting of liability by assuring that the company will not be exposed to an action for reimbursement of compensation payments.”

“The prudent contractor should still carry insurance coverage for the existing exposure,” Bobadilla said.

Subrogation

While the indemnity and legal issues play out, it’s important to remember to evaluate the subrogation potential on a CD claim. Shannon and Bobadilla outline several steps towards making a subrogation claim. They include:

• Reserving subrogation rights;

• Retaining relevant evidence to prevent spoliation;

• Investigating subrogation potential;

• Pursuing potential sources of recovery early, before evidence and witnesses are lost and to avoid statute tolling;

• Ensuring a subrogation claim is filed timely;

• Confirming subrogation rights are preserved by release or subrogation language at time of settlement;

• Obtaining a subrogation receipt where appropriate

A subrogation receipt is helpful when a carrier expects to pursue subrogation. “Insurers typically prove the right of subrogation with a document called an assignment or subrogation receipt,” according to Shannon. “With this document, claimants pass their rights to the insurer in exchange for the insurer’s payment. If insurers make a recovery, they will reimburse the claimant for any sums, such as a deductible, that may still be due.”

Assignment receipts vary from insurer to insurer, Shannon said. Usually, claimants assign their entire claim to the insurer; but they sometimes preserve part of a claim for themselves and are free to pursue that portion of the claim against any responsible party.