Construction Defect Claims In Colorado

Transcription

1 Construction Defect Claims In Colorado Current Issues Involving Construction Defects Session I.C. Damage Liability - The Extent of Liability For Construction Defects January 24, 2003 Presented By Robert H. Pratt, FCPE

2 Construction Defect Claims In Colorado Damage Liability The Extent of Liability For Construction Defects INTRODUCTION Robert H. Pratt, FCPE The author has been an expert witness on behalf of Builder, Contractor and Subcontractor claimants in approximately two-thirds of his engagements. The other third of his engagements have involved some form of expert opinion on behalf of the defendants or respondents to Home Owners or Home Owner Associations, Subcontractors or Contractors claims. This presentation will focus on the use of Forensic Estimating techniques that have proven to be valuable in helping both plaintiffs and defendants. Typically, plaintiffs must set forth the basis for any Construction Defect claim with specificity. The scope of repair work and the estimated cost to repair the identified defective work must be clearly defined and be a representation of the reasonable value of the cost to correct the cited defects. The courts in Colorado do not allow plaintiffs to assert damages for defective construction on the basis of speculation or interpolation of repair work quantities or scope. Defendants, upon receiving the plaintiffs declaration of defects and the estimated cost of repair, must then, as part of their defense of the allegations, investigate the appropriateness of the identified defects, and render a corresponding identification of the scope of repairs and an estimate of the reasonable cost to repair the defects found to have merit.

3 One of the recognized methods of measuring the magnitude of damages involved in a construction defect case is the determination of the diminution in value of the property with the defects in comparison to the value of the property if it had none of the cited defects. Alternatively, the measure of damages might be the value of the actual costs to repair the defects. The Supreme Court of Colorado, in its Landmark Decision in the case of John P. SLOVEK v. the Weld County Board of Commissioners v (723 P.2 nd 1309), (1986), makes several precedence setting statements: Since the goal of the law of compensatory damages is reimbursement of the plaintiff for the actual loss suffered, there may, of course, be instances in which repair or restoration cost may be a more appropriate measure... [than] market value before and after the injury... The Supreme Court continues: We do not agree that damages in the present case must be limited to diminution of market value. The measure of damages for injury to real property is not invariable.... Each case must be evaluated under its own circumstances. We conclude, however, that the considerations governing what is an appropriate case for departure from the market value standard are not susceptible to reduction to a set list and that no formula can be devised that will produce litmus-test certainty and yet retain the flexibility to produce fair results in all cases Demand Construction Services, Inc. Page 2

4 In other words, there is no definitive means for establishing the reasonable measure of damages, but the methodology must remain flexible to remain equitable. The SLOVEK case decision continues: The trial court must take as its principal guidance, the goal of reimbursement of plaintiff for losses actually suffered, see Zwick v. Simpson, 193 Colo. At 38, 572 P.2d at 134, but must be vigilant not to award damages that exceed goal of compensation and inflict punishment on defendant or encourage economically wasteful remedial expenditures by plaintiff. Finally, the trial court must articulate reasons for its decision so as to facilitate effective appellate review. Thus, the Supreme Court of Colorado has expressed its intent not to encourage economically wasteful remedial expenditures. It is in light of the Slovek case that this presentation provides additional alternatives to the measurement of damages to property that fall within the discretion of the trial court to adopt as a reasonable means for awarding damages on a case-by-case basis Demand Construction Services, Inc. Page 3

5 COST TO CORRECT DEFECTIVE CONSTRUCTION The preferred method of measuring the damages sustained by an Owner, as the result of defective construction work performed by a Contractor, is the computation of the Cost To Correct the work. This method is suitable for many types of work, including the work of finish trades such as painting, or tile work, or suspended ceilings, or interior doors, etc. This method, however, is less suitable for measuring the damages sustained as the result of defective construction involving concrete work, masonry work, structural steel work, and rough carpentry work. Essentially, defects in the foundation or structural framework of a project are frequently so costly to correct that even if the defect is detected in a timely manner, the fix will often involve some compromise of the design or the tolerances originally specified. SHOULD ANOTHER FORM OF COMPENSATION BE DUE? The question then becomes, should a Contractor or Builder be expected to perform corrective work, to the extent that such corrective work is feasible, as well as be liable for some other form of compensation to the Owner? Such compensation would be in consideration for the Owner s acceptance, or partial acceptance, of work that fails to meet the requirements as detailed or specified by the project s design professional. The answer is yes. The Contractor or Builder should generally be liable to the Owner for some additional form of compensation. This type of issue, however, rarely gets addressed in a claims proceeding Demand Construction Services, Inc. Page 4

6 THE PRACTICE OF HORSE TRADING The reason that many issues that would otherwise involve compensation to an owner for the acceptance of non-conforming work is that most Contractors will endeavor to Horse Trade away their liability for their mistakes. Sometimes Owners aren t even aware of such trades taking place. Sometimes the mistakes of design professionals will be corrected, without a written Change Order, in exchange for the design professional s acceptance, on behalf of the Owner, of non-conforming work by the Contractor. Failure by a design professional to disclose trades of this nature can be considered a breach of ethical principles and integrity, and a breach of contractual responsibilities as well, but that is another type of action beyond the scope of this presentation. Such tradeoff practices are more common than either the general public, or less sophisticated Owners may realize. As long as the tradeoffs are relatively minor and inconsequential, and the dollar amounts involved are somewhat trivial, such contract administration practices can be considered pragmatic and helpful in facilitating the timely completion of construction projects. When construction defects are major, however, or when the consequences are anything but trivial, the issue of defective construction warrants proper documentation, proper consideration, and a written resolution mutually acceptable to the parties. Should the parties fail to come to a mutually agreeable resolution, then at that point defective construction will become an issue to be resolved in one of the dispute resolution forums available to the parties. ECONOMIC WASTE DEFINED 2003 Demand Construction Services, Inc. Page 5

7 When an Owner seeks to recover damages from a Contractor for the Cost To Correct defective construction, there is a judgmental threshold or limit to the magnitude of the recoverable damages that will be allowed. The conceptual term Economic Waste is employed to identify that judgmental threshold or limit. To define the principle of Economic Waste, the following examples are presented. 1) If the defective construction is improper step-flashing between a wall and a lower roof surface, and the actual cost, or Forensic Estimate of the probable cost to correct that condition, is $1,000, and if the failure to correct the condition could result in periodic water damage to interior drywall and insulation over an extended number of years, resulting in water damage costs well in excess of the cost to correct the defect, in such a case the $1,000 cost would be allowed as an appropriate measure of the Owner s damages, because the periodic repairs are not only costly, but a distinct annoyance. 2) By contrast, if a plumbing contractor happened to install a 1/2 copper pipe to a bathtub that was specified to be 3/4 copper, causing the rate of fill to be 3 minutes longer each time someone took a bath, and if the actual cost, or Forensic Estimate of the probable cost to tear out the tile and wall and ceiling elements in order to gain access to the incorrectly sized pipe, so that the correct size could be installed and the walls rebuilt, is $1,000, in this latter case, the $1,000 cost would likely be considered Economic Waste, because the inconvenience would be considered tolerable. In general, there has to be some analysis of the ratio between the cost to correct the defect and the economic benefit derived by that expenditure. If the benefit-tocost ratio is not favorable, or greater than 1, then the Cost To Correct will in all likelihood be classified as Economic Waste Demand Construction Services, Inc. Page 6

8 STRUCTURAL AND PUBLIC SAFETY DEFECTS If the defective construction involves some structural flaw or deficiency, or if it involves some life-safety omission or deficiency that will cause the owner, occupant, or public to be endangered to a greater extent than is tolerable, such a situation will generally be considered an exception to the Economic Waste limitation. Under such circumstances the damages that can be recovered will most likely be based on a Forensic Estimate of the Cost To Correct the defective construction. DIMINUTION IN MARKET VALUE CAUSED SOLELY BY DEFECTIVE CONSTRUCTION Typically, the determination of whether or not a project or property is experiencing a diminution in value as the result of defective construction is a matter deferred to a qualified real estate appraiser. The author s experience has been that construction defects rarely play a measurable role in the valuation of a property. When construction defects are significant enough to be noted, the appraiser will often site the cost to correct the defect as the appropriate adjustment in the value of the property. Because appraisals are based on the Comparable Properties approach, the Cost approach, or the Income approach, the existence of defective construction in a property will frequently be neutralized by a strong market, or it will have a negligible effect or influence on the property s ability to generate income Demand Construction Services, Inc. Page 7

9 NEW ALTERNATIVE METHODS Because there is such a strong potential that both of the above methods of calculating damages due to defective construction will result in a value that constitutes Economic Waste or no measurable diminution in market value, there is a need to consider alternative methods of computing damages due to defective construction that are recoverable. Five alternative methods will be considered in the paragraphs that follow. FORENSIC ESTIMATE OF CONTEMPORANEOUS WORK THAT WOULD HAVE CORRECTED THE DEFECTIVE WORK. This approach to computing damages is different from the traditional method of computing the Cost To Correct defective construction once the project has been substantially completed. Once a project has been substantially completed, the potential that the Cost To Correct will rise to the level of Economic Waste, is much greater. Instead, this approach involves the preparation of a Forensic Estimate of what it should have cost to correct the defect, had it been detected at the time the defective work was originally performed. The distinction in this methodology emerges from the fact that defective work is frequently allowed to go uncorrected until a later date. At the later date, the defective work may become the substrate for subsequent work by other trades, or access to the defective work area may have become more restricted. In such a circumstance, the cost to properly correct the defective work may indeed rise to the level of Economic Waste. This is because the corrective efforts may significantly impact or damage the adjacent or subsequent elements of the project. When such a dilemma arises, and an Owner must make a tough decision to either direct the Contractor to 2003 Demand Construction Services, Inc. Page 8

10 perform corrective work despite its negative effects, or to live with or accept the defective and non-conforming work, an Owner has the right to assert a claim for a credit or other consideration in exchange for that acceptance. A Forensic Estimate of the probable cost that the Contractor would have incurred in correcting the defective construction, even though the Owner may elect to go forward without insisting that the corrective or remedial work be performed, can be a reasonable basis for the recovery of damages from the Contractor. FORENSIC ESTIMATE OF COST TO CONCEAL OR CAMOUFLAGE DEFECTIVE WORK Whenever the cost to remove and replace defective work becomes cost prohibitive, or reaches the level of Economic Waste, the more appropriate measure of damages may be based on a Forensic Estimate of the reasonable cost to properly cover up, disguise, or camouflage the defective work. This method of defective work correction would not be acceptable if the defective construction involved a structural or life-safety hazard. It would, however, be appropriate whenever the defective construction is mainly cosmetic in nature. FORENSIC ESTIMATE OF HIGHER COST TO PERFORM WORK FREE OF DEFECTS Sometimes defective construction results from a Contractor or Subcontractor taking shortcuts in its execution of the work. Sometimes it comes from carelessness or the failure to properly supervise or manage the crews performing the work. Under such a circumstance, if there is no structural or life-safety factor 2003 Demand Construction Services, Inc. Page 9

11 necessitating that corrective work be undertaken, then the more appropriate measure of damages might be based on a Forensic Estimate of the difference between the Contractor s probable cost (or actual cost if available) to perform the work defectively, and what the Contractor s cost would have been had the Contractor performed the work with the appropriate crew mix and size, supported by the proper amount of equipment and tools, and supported by the proper level of supervision and management. This approach would transfer the economic benefit or savings derived by the Contractor s ill-advised shortcuts to the Owner. FORENSIC ESTIMATE OF NON-CONFORMING WORK ACCEPTANCE DISCOUNT This method involves the quantification of that portion of the work or phase of the project that has been performed correctly, and that portion that has been performed incorrectly. Again, this situation might arise when the defective work is intermingled with work performed correctly, and the process of correcting the defective work would also involve destruction of that portion of the work that was performed properly. If it is tolerable for the defective and non-conforming work to be accepted together with the conforming work, then a Forensic Estimate of the ratio of non-conforming work to the work as a whole, and the determination of the value of that element of the project, can be used to derive an amount by which that work should be discounted. As with the previous method, the intent is to transfer the benefit of the bargain to the Owner, and thereby precluding the Contractor from deriving economic benefit from an Owner s or design professional s decision to forego removal and replacement of an entire element or phase of the project Demand Construction Services, Inc. Page 10

12 FORENSIC ESTIMATE OF PROFIT AND OVERHEAD FORFEITURE Occasionally, an Owner will forego requiring the Contractor s removal and replacement of defective construction, thereby accepting the non-conforming work, provided the Contractor will forfeit any markups for profit, overhead, or both, on that portion of the work that was defective. Under such circumstances, the appropriate measure of the damages or forfeiture would be based on a Forensic Estimate of the Contractor s markups as applied to a determination of the value of that portion of the contract work scope. Sometimes a Contractor will volunteer such information. There are situations, however, when the relationship between an Owner and a Contractor is so adversarial that an Owner may have to engage a consultant to compute a reasonable value independently. CONSEQUENTIAL DAMAGES Consequential Damages can include such elements as lost income or rents, extended costs for current facilities, lost production capacity, or lost sales, and increased costs to administer the delayed contract completion, etc. Consequential damages incurred by an Owner as the result of a Contractor s breach of the contract are more difficult to quantify in a manner that makes them eligible for recovery in most dispute resolution forums. They are frequently speculative in nature, and most courts are reluctant to award such classes of damages in construction cases. There are exceptions, however, and careful enumeration of the elements and the derivation of reasonable values for each element can increase the chances that a neutral will include such damages in an award. Sometimes the recovery of Liquidated Damages will be the basis for precluding Consequential Damages. When actual damages are sought in the absence of any Liquidated 2003 Demand Construction Services, Inc. Page 11

13 Damages provision in the contract, some forms of Consequential Damages become allowable. Any Forensic Estimate of Consequential Damages should be prepared in conjunction with the assistance of knowledgeable legal counsel on the advisability of including each element of damages being sought. RECOVERY OF INTEREST DAMAGES If a Contractor breaches the terms of a contract by either performing defective construction, or by completing the project after the specified contract completion date, it is possible that the Owner will be entitled to recover increased loan carrying or interest charges. Sometimes the computation of interest charges is relatively simple and straight forward. Sometimes the computation can be very complex, and might involve the preparation of a Forensic Estimate of the difference between the actual and reasonable as-planned cash flow and loan drawdown rates. There are significant differences between the applicable laws in each state, and between types of contracts with regard to recovery of interest charges. Therefore, project Owners should be cognizant of the laws and specific contract provisions that affect the recovery of this type of cost. CONCLUSION Forensic Estimating is a process that entails the identification, quantification, and pricing of each element of damages that either a Contractor or an Owner might assert against the other party. It is a technique that lends itself to the determination of an appropriate measure of the damages that should be attributed to defective construction. This is especially true when accounting records are not adequate to 2003 Demand Construction Services, Inc. Page 12

14 properly segregate costs. Sometimes a detailed Forensic Estimate is the only way that recoverable damages can be isolated from other commingled costs that should be excluded from the calculation of damages for a particular case Demand Construction Services, Inc. Page 13