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PREVENTIVE LAW: PREVENTING CONSTRUCTION LITIGATION
While most individuals go to a medical doctor for periodic checkups, the
patient does not typically come to a lawyer until a dispute is hemorrhaging.
There are many preventive measures that can be taken to reduce the need
or eliminate the need for legal intervention. First, it is critical to
make a record of all proposals. Even if the amount involved does not justify
a formal contract, there is no reason that a confirming letter, facsimile
or email cannot be sent. The preferred mechanism is to send an engagement
letter with a signature line for the prospective client to sign and a
self-addressed, stamped envelope. Even without the client's signature,
if an engagement letter or fax is sent to a client, the client does not
object, and the contractor or architect rendered services based upon that
letter, the law will create an enforceable contract whatever terms are
set forth in that letter.
Such record-keeping is especially important when extras and change orders come into play. These are among the most commonly litigated issues and can be easily eliminated by a confirming letter. Recognizing the realities of construction administration and the difficulty of obtaining a signature on a construction site, at the very least a confirming fax, email or text message should be sent the next day which sets forth the nature of the extra, the cost of the extra, the individual who authorized the extra work and the effect of the extra work on any time schedule. These types of preventive measures both minimize the need for an attorney involvement and make it much easier once an attorney has to be involved.
If a pre-printed contract is used, a contractor or design professional
should ensure that the contract addresses California state requirements.
For example, if a national form such as an American Institute of Architects
(AIA) form is employed, that form may not address requirements unique
to California. Also, effective January 1, 1993, extensive notice provisions
have been added for all residential construction. In addition, if the
contract involves home improvement to a residence, there are certain additional
requirements that must be contained within the contract that are not found
within national forms. Also, architects are required to have prescribed
information in a written contract.
Along the lines of documenting proposals, there is a need to document disputes, or the lack thereof. If, in the process of collection, somebody in your office contacts a client who tells you that a check is in the mail, that they are having a cash-flow problem, or they have not been paid by the owner, it is good practice to send a confirming letter to document the fact that the reason you have not been paid is because of a cash-flow problem. This helps to negate disputes that are often concocted on the steps of the courthouse or arbitrator's office.
In order to maximize one's legal position, one should avoid abandoning a job before its completion whenever possible. This will eliminate the owner being able to receive a credit or back charge in the amount of the sums necessary to have the work completed by other contractors. Typically, this sum will far exceed the amount of money you would have to spend to complete the work. Also, in many instances this may be warranty work which would cost you virtually nothing. Prior to taking any measures, it is important to look at the appropriate termination section of any contract. Most contracts require written notice and a set time period prior to taking any steps to terminate the contract.
It should be kept in mind that when you agree to perform services for somebody and to be paid overtime, you are essentially agreeing to extend credit to the individual. Unless you are being paid directly from a bank or you have adequately protected your mechanics or designer's lien rights, one should scrutinize the credit history of the customer. I have encountered many situations where a contractor or architect goes into a project knowing full well that there will be financing problems or a monetary short fall. These circumstances should present a red flag to the contractor that there will be a payment problem. Even if one does not do a formal credit report on a prospective client, it is good practice to elicit as much information as possible as to the type of entity, principals involved, bank references, credit references, etc. It is also good practice to copy all incoming checks. This is helpful for several reasons: First, it can help to tell you what type of entity with which you are dealing. It is not uncommon to be contracting with one entity, but to receive a check from a limited partnership or limited liability company which has been established for the purposes of paying construction-related debts. Secondly, in the event that an arbitration award or judgment has to be enforced, the contractor or designer can levy on that bank account and not have to spend a lot of money looking for assets. Many companies extend substantial amounts of credit to an entity whose form they are unsure of and do not perfect lien rights. It can be critical to know with whom you are dealing, because in the event of a corporate obligation, it is good practice to attempt to obtain a personal guarantee.
Most construction contracts contain an arbitration clause. The most common reasons for using arbitration (and the probable reason arbitration clauses are inserted in form AIA contracts) is that such procedures are traditionally less expensive, quicker, and avoid the risk of a jury trial. However, a simple, undisputed case can often be resolved quicker and less expensively by the obtaining of a default or summary judgment in the court process. Similarly, as arbitration administrative fees escalate, a client may wind up spending $1,500.00 to obtain a judgment in a situation where they could obtain the same judgment for roughly $450.00 in court costs by simply filing a lawsuit and obtaining a default judgment. Furthermore, many arbitration tribunals have initiated pretrial conferences which can slow down and increase the expense of the arbitration process. Finally, many people do not like the arbitration process because of the limited scope of review of an arbitration award. While a capricious judge or jury can be attacked by an appeal, a bad arbitration award can only be vacated based upon very limited grounds and for a very limited period of time. Notwithstanding this, from an errors and omissions standpoint, arbitration will be preferred because it will tend to limit one's exposure since an arbitration award is generally going to be substantially less than a jury award.
Changes to Lien Releases
Effective July 1, 2012, there have been changes in California to the prescribed
forms for Conditional Waiver and Release Upon Progress Payment and for
Unconditional Waiver and Release Upon Progress Payment. Any enforceable
releases after this date must substantially comply with these revisions.
The lien releases only apply to release mechanics lien, stop work notices,
and bond rights and not the underlying contract rights between the parties.
The lien releases do not affect retentions retained before or after the
release date, extras furnished before the release date for which payment
has not been received, or extras or items furnished after the release
date. Significantly, the amendments make it clear that if there is a written
change order which has been fully signed by both parties, rights based
upon work performed or items furnished under the change orders are covered
by the release unless specifically reserved by the claimant in the release.
Significantly, subsection (b) of Civil Code section 8124 provides that whether the release is conditional or unconditional, the lien is invalid if the payment is not actually received.
Owner's Measure of Damages
The California Supreme Court held in Ehrlich v. Menezes that where a contractor's
negligence causes a homeowner only economic injury and property damage
(not physical injury), only contract damages lie and a claim for emotional
distress is precluded. The available damages for defective construction
are thus limited to the cost of repairing the home, including lost use
or relocation expenses, or the diminution in value. This is called the
economic loss rule.
When a contractor, subcontractor or design professional is found liable to the owner for defective construction, the measure of damages has always been either diminution in value or the cost of restoration, whichever is less. The owner cannot receive both diminutions in value and restoration costs since that would constitute a double recovery. However, in 1990, the court of appeal held in Orndorff v. Christiana Community Builders that if the homeowner has a "personal reason" for repairing construction defects in his home, the owner may be awarded the costs to repair the home, even if that cost is greater than a loss in value to the property created by the defects.
Limitation on Liability
In Markborough California v. Superior Court, the California court of appeal
approved a construction professional limiting liability to the amount
of the construction fee. Even though the provision in question was in
a standard form contract, it was mailed with a cover letter that stated:
"If the contract documents were acceptable to you, we can begin work
as soon as we receive a copy of the signed contract. We would, of course,
have to approve any requested changes for proceeding." This provision
suggested that the customer was not stuck with the contract and liability
clause but had the opportunity to make changes.
The contract in question contained a limitation of liability clause limiting the engineer's liability to the greater of $50,000.00 or to the engineer's consulting fee. The engineer was paid $67,640.00 for its services and this provision was effective to limit any claim for errors and omissions to $67,640.00. Given the fact that the plaintiff claimed over 5 million dollars in expenses to remedy the design problem in issue, this was a very significant provision. The court probably would not have upheld this provision, however, absent some evidence that the contract was negotiable. In addition, based upon the court's application of Civil Code section 2782.5, it is unlikely such a provision would be upheld in another type of contract.
Working with an attorney experienced in construction law can save you money and aggravation in the long run.
Mechanics Liens, Design Professional Liens, and Stop Work Notices in a Nutshell
The Preliminary 20-Day Notice
In discussing lien rights, many architectural firms have traditionally
been reluctant to serve a
preliminary notice at the inception of the relationship. However, a preliminary notice must
be filed at the beginning of the job or else it will only relate back
20 days from the date of the service. A preliminary notice is the only
way to protect an architectural firm or subcontractor when they have been
hired by somebody other than the owner of the property. If there is a
direct contractual relationship with the owner, a preliminary notice need
not be filed. However, a recent change requires one with a direct contractual
relationship with the owner to serve a preliminary notice if a construction
lender is involved in the project. Similarly, if one is originally hired
as a subcontractor, but then establishes an independent relationship with
the project owner, a preliminary notice may be unnecessary. The use of
the preliminary notice is a business decision and must be weighed against
the public relations consequences.
The mechanics lien area is a very complicated area with very strict formal requirements. For example, the preliminary notice must be sent by personal service or certified mail, return receipt requested, to the owner, general contractor, and any known bank. The green return receipt must be kept. It is very common for these notices to be sent by ordinary mail, or for someone to lose the return receipt. It is equally common for the preliminary notice to be served at the end of the project when it is too late.
In California, prior to the initiation of construction, only a design professional lien
is available. This lien will be discussed below. Once construction has
been commenced, the mechanics lien is the only mechanism for the subcontractor
to create a relationship with the owner of the property. Similarly, the
stop payment notice is the only mechanism to create a relationship with
the lending institution which may be financing the construction.
It should be kept in mind that unless one is a general contractor ( i.e., one has a direct relationship with the property's owner) is necessary to send the 20-day preliminary notice to the general contractor, owner and financial institution. The 20-day preliminary notice is required before a mechanics lien or stop notice can be filed on a private job.
It should also be kept in mind that after completion, the commencement of the lien period occurs 60 days after cessation of the job, 30 days after notice of completion has been filed or upon acceptance of the work or occupation of the project by the owner. A cessation is a cessation of work on the project, not necessarily a cessation of work that has been performed by your company.
From that time period, one has 90 days to record a mechanics lien. Accordingly, there may be a 150-day period to record the lien, consisting of 60 days after cessation of labor, followed by 90 days after the end of the cessation.
After the mechanics lien has been recorded, if the job has been completed, one must file a lawsuit within 90 days to perfect lien rights. If a lawsuit is not filed and the project has been completed, the lien should be released because it is no longer in effect and merely serves as an illegal cloud on title. In such a situation, the wrongful lien claimant may be subject to monetary damages.
The Design Professional Lien
Effective January 1, 1991, a new weapon to ensure payment of a design professional's
fees was created in California. Under previous law, architects, engineers,
land surveyors, and designers were limited to the same remedy as a contractor
or materialman, i.e., filing a mechanics lien. By filing such a lien,
the design professional could file suit to foreclose on a lien if properly
perfected and seek the reasonable valuable of the services or the contract
price, whichever is less. However, when plans were drafted or services
were performed, but no construction commenced, no mechanics' lien rights
came to bear.
California Assembly Bill 1789 created a new design professional's lien. On July 1, 2012 these provisions were reenacted at Civil Code 8300 through 8319. From that point on, any certificated architect, registered professional engineer, or licensed land surveyor may be eligible to file a design professional's lien. Unlike a mechanics lien, the absence of commencement of actual construction of the planned work of improvement does not bar foreclosing on the design professionals' lien. However, no such lien can be filed unless a building permit or other governmental approval has been obtained in connection with the services rendered by the design professional. (see Civil Code section 8302). Thus, while commencement of construction is the triggering mechanism of the mechanics' lien, obtaining a building permit or other governmental approval is the triggering mechanism for the design professionals' lien.
For a design professional to be entitled to a lien, all of the following must occur:
- A building permit or other governmental approval must be obtained.
- There must be a written contract between the design professional and the landowner.
- The landowner must default in payment or refuse to pay the design professional by the written contract.
- The design professional must make a written demand for payment specifying that a default has occurred and the amount of the default. This written demand must be mailed by first-class registered or certified mail, postage prepaid, but no return receipt is required. This notice must be given at least ten days before recording a notice of lien.
Like a mechanics lien, the design professional lien expires 90 days after recording a notice of lien, unless the design professional files suit to foreclose on the lien within 90 days of recordation. Also, the design professional lien expires on commencement of the work of improvement (since the mechanics lien is available at that point). The only other limitation on filing a design professionals' lien is that the notice of lien must be recorded no later than 90 days after the design professional knows or has reason to know that the landowner is not commencing the work of improvement.
The Effect of Recordation of a Preliminary Notice
California law requires the county recorder to notify a subcontractor when
a notice of completion or a notice of cessation is recorded on a particular
private works project. Since the deadline for filing a mechanics' lien
depends upon when either of these notices is recorded, this new procedure
will help prevent missing the critical period. As such, in many instances,
the new procedure will enable the claimant to get paid on a project and
not lose important lien rights.
California Civil Code section 8214 permits a claimant to file its 20-day preliminary notice with the recorder's office in the county where the job site is located. This is in addition to the requirement of mailing this notice by certified mail, return receipt requested, as described above. There is a nominal filing fee and the recorder's office requires both the claimant's signature and date must be an original (not a copy). If you include an extra copy of the notice with a self-addressed, stamped envelope, the recorder's office will mail a conformed copy which indicates the date and time it was filed. Afterwards, once an owner records a notice of completion or a notice of cessation, the recorder's office will mail the claim and a notice of when either of these documents has been recorded. Once the claimant receives this notice, it should immediately record a mechanics lien, serve a bonded stop notice and a notice of surety on payment bond (if appropriate), or consult an attorney for advice on these matters. Once these steps have been taken, it is then crucial to calendar a follow-up date to ensure the lawsuit is filed within the prescribed time periods. Similarly, regarding California public works projects, California Civil Code section 9362 provides that if the claimant, at the time of filing its stop notice, pays to the public entity a prescribed sum, the public entity must give to each stop notice claimant, notice of the expiration of the stop notice period by personal service or certified mail. This notice must be given to stop notice claimants no later than 10 days after the filing when notice of completion or after the cessation of labor has been deemed a completion of the public work, or after the acceptance of completion, whichever is later. There is a nominal fee for obtaining this information which is payable to the public entity.
The Utility of the Bonded Stop Notice
On a private project in California, an additional procedure that can be
used to protect rights is to serve a bonded stop notice on the construction
lender. This notice must be completed within the time period that any
mechanics lien could be recorded against the project. Needless to say,
the longer the wait, the less funds will be held by the lender due to
the disbursements being made as the job progresses.
To accomplish this procedure, the claimant or its insurance agent could contact a bonding company. The company should be advised that you desire to obtain a bond for a stop notice on a private work. They will ask you various questions concerning the project and will have you complete an application for a bond. Please have them send the original bond directly to your office. Upon receipt, an attorney can prepare a stop notice and serve it on the branch where the construction funds are being held. It is critical to serve the right branch or else it can result in a stop notice being defective. In some factual circumstances, the filing of the stop notice may be the only means to recover money. For example, if a contractor is insolvent, and the owner files bankruptcy, the bonded stop notice may still get the claimant paid. Many contractors have a practice of serving a stop notice on a lending institution when the notice is not bonded. Most lending institutions will simply ignore such a notice and they are not required to pay attention to it absent the bond.
While provisions limiting liability have been upheld in construction contracts, provisions which seek to eliminate liability for negligence or willful misconduct are void as against public policy. See California Civil Code section 2782.
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