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K&L Construction Law Blog

Legal issues, news, and regulations concerning the construction industry

FIDIC Update: Termination and the Employer’s obligations under the Red Book

Posted in Articles and Publications, Europe

By Mike R. Stewart, Mary E. Lindsay, and Nita Mistry, K&L Gates, London

A Privy Council case last year provided some important guidance on the provisions in the FIDIC Red Book in relation to Employer’s financial arrangements and claims.  Whatever your perspective might be, when negotiating or managing a contract based on the FIDIC Books, employers and contractors should be aware of the Privy Council’s findings in NH International (Caribbean) Ltd v National Insurance Property Development Company Ltd (Trinidad and Tobago) [2015] UKPC 37.

The Contract

National Insurance Property Development Company Ltd (Trinidad and Tobago), the Employer, employed NH International (Caribbean) Ltd, the Contractor, to construct a hospital in Tobago under a contract in the form of the FIDIC Red Book.

On 2 November 2006, the Contractor terminated the contract pursuant to Clause 16.2.  The Employer did not agree the termination was valid but the parties proceeded as if the contract had been terminated.  A number of issues arose during the Engineer’s assessment of the work to the date of termination and these matters, including the validity of the termination, were referred to arbitration.

The arbitrator’s decisions in relation to Clauses 2.4 and 2.5 and Clause 16.1 were later appealed first to the High Court and the Court of Appeal in Tobago and then to the Privy Council.

FIDIC Red Book Clause 2.4 and the Privy Council Judgment

Clause 2.4 provides that the Employer “shall submit within 28 days after receiving any request from the Contractor, reasonable evidence that financial arrangements have been made and are being maintained which will enable the Employer to pay the Contract Price … in accordance with clause 14”. Clause 16 allows the contractor to suspend and terminate if reasonable evidence is not provided within certain timescales.

Pursuant to that provision, the Contractor made a request under clause 2.4 for evidence of the Employer’s financial arrangements incuding evidence that the funding for the project had Government approval.  The Employer confirmed that it was able to pay but, when the Employer would not confirm that payment had been approved by the government, the Contractor suspended work.  The Employer later confirmed that  the money was available and that the Contractor would be paid.  However, the Employer still failed to answer the Contractor’s request for confirmation that the government had specifically approved funds.  Consequently the Contractor terminated pursuant to Clause 16.2.

In relation to Clause 2.4, the arbitrator found that, in order to comply with the provisions of the clause, the Employer was required to do more than show “the employer is able to pay” and “was enthusiastic about the project”.  The Privy Council agreed with the arbitrator that the Contractor’s termination of the contract in these circumstances was valid.

FIDIC Red Book Clause 2.5 and the Privy Council Judgment

Clause 2.5 provides that:

  1. If an employer “considers itself to be entitled to any payment under any Clause of these Conditions or otherwise in connection with the Contract”, it should, subject to certain specified exceptions “give notice and particulars to the Contractor”;
  2. The notice shall be given as soon as practicable after the Employer became aware of the event or circumstances giving rise to the claim”;
  3. The particulars shall specify the Clause or other basis of the claim, and shall include substantiation of the amount … to which the Employer considers [it]self to be entitled”, that the amount should be assessed by the Engineer, and that it “may be included as a deduction in the Contract Price and Payment Certificates”;  and
  4. The amount so determined “may be included as a deduction in the Contract Price and Payment Certificates” but that the Employer should only be entitled “to set off against or make any deduction from an amount certified in a Payment Certificate, or to otherwise claim against the Contractor, in accordance with this sub-clause”.

Clause 16.4 entitles a contractor to claim loss of profit or other loss or damage suffered as a result of the termination.  In response to the Contractor’s claims under Clause 16.4, the Employer counterclaimed a right to set-off its claims pursuant to the provisions of Clause 2.5.  The arbitrator decided that the wording of Clause 2.5 was not sufficiently clear “to exclude common law rights of set-off and/or abatement of legitimate cross-claims”.  The Employer’s “counterclaims” should be allowed.

The Privy Council, however, disagreed with the arbitrator.  The Privy Council said, at paragraph 38 of the judgment, that the purpose of Clause 2.5 “is to ensure that claims which an employer wishes to raise, whether or not they are intended to be relied on as set-offs or cross-claims, should not be allowed unless they have been the subject of a notice, which must have been given “as soon as practicable””.  Otherwise, if “the Employer could rely on claims which were first notified well after that, it is hard to see what the point of the first two parts of clause 2.5 was meant to be””.

The Consequences for Employers

In its interpretation of Clause 2.4 and of Clause 2.5 the Privy Council decided upon the interpretation that favours best that giving both parties’ full knowledge of circumstances.

For good reason, the Privy Council held that it was not sufficient under a re-measurement contract to simply say that it has access to funds and an intention to pay.  Instead, the employer must, in response to a Clause 2.4 request, provide “evidence of ’positive steps’ on the part of the employer which showed that ’financial arrangements’ had been made to pay sums due under the Agreement”.

An employer’s obligation to give full financial information, as described above, follows the obligation to pay the contract price.  It is ultimately fair that a contractor under a re-measurement contract should be entitled to confirmation and comfort that it will be paid in the event of a variation.  The time period to do so, 28 days, may not be long enough for many employers and particularly so for larger employers who often have complex financial reporting requirements.  It was not enough time for the Employer in NH International (Caribbean) Ltd v National Insurance Property Development Company Ltd (Trinidad and Tobago).  Thought should be given at the outset of a contract as to how an employer will respond to a Clause 2.4 request, if the clause is to remain unaltered.  Alternatively, the parties might consider amending the clause so as to satisfy a requirement for financial information at the outset.

Similarly, the Privy Council was clear that Clause 2.5 applies to any claims which an employer might wish to bring.  In addition, the clause meant that the  employer must make its claim “promptly and in a particularised form” otherwise it will not be able to bring the claim.

The Privy Council noted also that, to allow otherwise and permit claims that were made late, these claims could not be determined by the Engineer.  The Engineer’s function in this regard is linked to the particulars which must be contained within the notice given as soon as practicable.

Again, employers must be wary of delay in making any claims and so should manage the contract so as to be able to make any such claims as soon early as possible.

Personal Property Securities and the Construction Industry

Posted in Articles and Publications, Asia Pacific

By Belinda Montgomery, Leonard McCarthy and Sandra Steele, K&L Gates, Sydney

It seems hard to believe but come 30 January 2016, the Personal Property Securities Act 2009 (Cth) (PPSA) and the register it established will have been operating for 4 years. The PPSA has introduced far reaching conceptual and practical changes to Australian law. If you are part of the construction industry, to protect your rights, you need to ensure that any registerable interests are registered on the Personal Property Securities Register (PPSR).

How is the PPSA relevant to construction industry players?

Practices and concepts within the construction industry throw up a variety of ‘red button’ issues arising under the PPSA. These include:

  • equipment hire and temporary works – if the hire of equipment and temporary works is for more than a year, in certain circumstances, the supplier must register its interest to avoid losing the property, should the party to who the equipment and temporary works have been supplied, become insolvent. This also applies to certain goods required to be registered by serial numbers (e.g. motor vehicles), if the hire of the goods is for more than 90 days and the hire agreement was entered prior to 1 October 2015;
  • retention of title provisions – commonly, items are sold or supplied on the basis that they remain the property of the supplier unless and until the purchaser pays the purchase price for the items. For the purposes of the PPSA, this creates a security interest and should be registered;
  • retention money– although this is a ‘grey’ area under PPSA, the right to retain money by a principal (in respect of a head contractor) or a head contractor (in respect of a subcontractor) may constitute a security interest under the Act. Arguably therefore, a retention agreement in a construction contract constitutes a security interest created by the retaining principal or head contractor (as relevant) and should be registered; and
  • ‘step in’ rights – under a construction contract, if a contractor materially breaches the contract, it is common for the principal to have the right to take work out of the hands of the contractor to complete the works. The right to use any of the contractor’s property to complete the work on site, needs to be registered under the PPSA by the principal.

Practical considerations

The PPSA and PPSR come into particular focus when a company goes into insolvency.

The Hastie Group is a useful case study. The companies in the Hastie Group carried on a diverse engineering business with a focus on mechanical, electrical, plumbing, refrigeration and ventilation services.  In 2011, the revenue of the Hastie Group was approximately $1.9 billion. However, in May 2012, administrators were appointed to the Hastie Group. At that time, the business had approximately 1,600 projects underway throughout Australia and was engaged on approximately 1000 sites. It also operated from up to 40 different locations, in each state and territory of Australia.

The administrators appointed to the Hastie Group had a substantial amount of equipment in their possession belonging to third parties. The administrators were concerned that they would face particular difficulties trying to ascertain what property was in the possession of the Hastie Group and what rights the administrators should exercise in respect of that property.

There were 995 registrations noted in the PPSR. However, most of the registrations failed to specify in a meaningful way, which piece of equipment or security agreement the registration related to. The administrator wrote to all creditors who had an interest recorded against the Hastie Group in the PPSR, requesting that the creditor urgently provide notification of its interest. A substantial majority of those creditors failed to respond to the correspondence. Many of the creditors who did respond, failed to provide details that allowed the Administrator to identify which particular property the security interest related to.

The administrators applied (and obtained) orders under the Corporations Act 2001 (Cth) enabling them to sell the unclaimed equipment and keep the proceeds in a separate account until those claiming an interest in the property sold were able to establish their claim. If no claim was made within a certain period, then the administrators were able to use the proceeds of sale for the benefit of general creditors.

This represents the practical difficulties that arise under the PPSA and PPSR and the need for secured creditors, including lessors, to be able to quickly identify their equipment.

Washington Court of Appeals Confirms Enforceability of Termination-for-Convenience Clauses and Holds that Implied Covenant of Good Faith Places No Limits on Express Termination-for-Convenience Clauses

Posted in Case Summaries, The Americas

By D.C. Wolf, Brad Lewis, and Jesse O. Franklin, K&L Gates, Seattle

The contract law concept of a “termination for convenience” allows one contracting party to terminate a contract that has become inconvenient or unnecessary and settle with the terminated party for partial performance.  The doctrine originated during the U.S. Civil War to give the Union government flexibility when quickly changing battlefield conditions rendered a planned project or procurement overly costly or no longer necessary.[1]

In its recent decision in SAK & Associates, Inc. v. Ferguson Construction, Inc., No. 72258-1-1, 2015 WL 4726912 (Wash. Ct. App. Aug. 10, 2015), the Washington Court of Appeals, Division One, given very limited existing authority, clarified that partial performance of a construction project is sufficient consideration to support a termination-for-convenience clause and rejected the argument that the implied covenant of good faith and fair dealing limits a party’s ability to invoke such a clause.

In SAK, the subcontractor entered into a fixed-sum contract with the general contractor to provide concrete and paving services for the construction of airplane hangars.  Their agreement contained a termination-for-convenience clause, which provided as follows:

In addition to the rights listed above, Contractor may, after providing Subcontractor with written notice, terminate (without prejudice to any right or remedy of Contractor) the Subcontract, or any part of it, for its own convenience and require Subcontractor to immediately stop work.  In such event, the Contractor shall pay the Subcontractor for the work actually performed in an amount proportionate to the total Subcontract price.  Contractor shall not be liable to the Subcontractor for any other costs, including anticipated profits on work not performed or unabsorbed overhead.

After the subcontractor had been working for about four months, the general contractor invoked the termination-for-convenience clause, citing “phasing restrictions, site logistics, and basic convenience,” and required the subcontractor to stop work immediately.  The subcontractor sued, alleging that the contractor had breached their agreement by terminating it without cause.  The trial court granted summary judgment for the contractor, holding that it had properly invoked the termination-for-convenience provision of the contract.  The subcontractor appealed.

The Court of Appeals, Division One, affirmed the grant of summary judgment.  The subcontractor’s primary argument on appeal was that because the disputed clause allowed the contractor to terminate at its discretion, it was an unenforceable, illusory promise.  The Court of Appeals disagreed, noting that so long as there is “some restriction upon the power to terminate,” the right to terminate for convenience is not illusory.  The subcontractor in SAK had completed 24% of the project before being terminated, and the contractor had paid it for that proportion of the fixed contract price.  The court determined that this payment for partial performance was sufficient consideration to render the termination-for-convenience clause valid and enforceable.  Also, as is often the case in negotiated contracts, the contractor and subcontractor in SAK agreed that in the event the contractor exercised its power to terminate, the subcontractor was entitled only to a proportionate share of its overhead and profit based on the completed portion of the work.  The Court of Appeals reasoned that this too made enforcing the termination-for-convenience clause proper, because doing so would effectuate the parties’ intent as shown objectively by the express terms of the contract.

The Court of Appeals also held that the implied covenant of good faith and fair dealing does not limit a party’s ability to invoke a termination for-convenience clause.  Relying on a previous Washington case involving a government contract with a similar clause,[2]  the Court of Appeals held that the covenant of good faith and fair dealing does not trump express contract terms.

The SAK case reinforces the enforceability of termination-for-convenience clauses in Washington.  It also rejects the notion that the implied covenant of good faith precludes a party from invoking a termination-for-convenience clause.  The Court of Appeals cautioned, however, that “[w]e are not faced with an attempt to invoke a termination for convenience clause before the commencement of any work or only after a nominal amount of work.”  Thus, this decision leaves open whether a termination-for-convenience clause is enforceable if invoked before or just after the subcontractor has started work.  It also raises the question of how much restriction upon the power to terminate is sufficient to avoid a finding that the termination-for-convenience clause is illusory.  Parties should carefully consider these issues before invoking a termination-for-convenience clause.


[1] See, e.g., United States v. Corliss Steam-Engine Co., 91 U.S. 321 (1876).

[2] Myers v. State, 152 Wn. App. 823, 828, 218 P.3d 241 (2009).

Suspension and Termination Under the Civil Law, Part 1

Posted in Articles and Publications, Middle East

By Alexander Brightman, K&L Gates, Doha

INTRODUCTION

Although “freedom of contract” is a concept that is recognised in both the common law and civil law jurisdictions, the codified and prescriptive nature of a civil law system means that the relevant provisions of the Civil Code may even be implied into robustly drafted contracts, including standard forms. As set out below, such implied provisions could have the undesirable effect of delaying termination whilst a court order is obtained or exposing the terminating party to a claim for breach of contract (and compensation) for unlawful termination. In this article, I will be discussing suspension and termination rights under the FIDIC Contract (Red and Yellow Books), before examining the position under the Qatar Civil Code.  In a follow-up blog post, I will look at suspension and termination under the UAE Civil Code.

SUSPENDING AND TERMINATING UNDER FIDIC

Although suspension and termination rights are recognised in many Civil Codes, parties should always try and expressly agree on such provisions in their contracts. Contractual suspension and termination rights are often less ambiguous and more advantageous than equivalent rights under civil law.

Clauses 15 and 16 of the FIDIC Contract (Red and Yellow Books) set out the circumstances that may lead to a termination of the contract by the employer and, in the case of the contractor, suspension and termination (the former principally for payment related breaches). Both clauses describe the procedures that must be followed and the financial arrangements that will apply following suspension or termination. Critically, both clauses also contain wide-ranging termination events. For example, the employer can terminate the contract under sub-clause 15.2 due to abandonment of the works, failure by the contractor to provide a performance security, failure to comply with a Notice to Correct and contractor’s insolvency (to name a few). The employer is also entitled to terminate the contract for convenience under sub-clause 15.5.

Although most standard form subcontracts (including FIDIC) entitle the main contractor to terminate the subcontract immediately on notice in the event that the main contract is terminated, contracting parties should not assume that subcontracts have “back-to-back” suspension and termination rights. This point is particularly pertinent in the Middle East given the propensity for contracting parties to heavily amend standard form contracts. Furthermore, “back to back” is not a legal term and may not mean much to a Qatari judge or to a dispute resolution authority under Qatari law if its substance is not reflected in the subcontract with an express explanation of what clauses of the main contract are to apply by analogy or verbatim to the subcontract. As yet, no court in the State of Qatar has addressed the issue and no legal provision directly states whether such clauses are valid or not.

Further, as explained below, unless the termination clause in the subcontract unequivocally states the parties’ intention to allow termination by notice, the contract may not automatically terminate without a court order giving effect to the termination. Accordingly, a contractor seeking to terminate a subcontract on a “back-to-back” basis following the termination of the main contract without express wording permitting it to do so may inadvertently expose itself to a claim for wrongful termination.

SUSPENDING AND TERMINATING UNDER CIVIL LAW

Qatar Civil Code

If the contract is governed by Qatar law, the contract may only be terminated by the agreement of the parties, as prescribed by law or by an order of the court. If a contract is silent or the contractual terms are ambiguous in respect of the right of a party to terminate the contract unilaterally, a contractual party may under Article 183(1) apply to the court for an order terminating the contract in the event that the other party has failed to fulfil its contractual obligations. Before making the application, Article 183(1) requires the party seeking to terminate the contract to first give notice to the defaulting party of the default and its intention to terminate the contract. Article 183(2) grants the judge wide discretion in such circumstance to terminate the contract or determine a grace period within which the defaulting party must rectify the breach (e.g. a period in which the employer must certify or make payment to the contractor). It may also reject the terminating party’s application if it considers the breach is minimal in light of the defaulting party’s overall obligations under the contract.

Article 184(1) permits the contractual parties to agree to terminate the contract without obtaining a court judgment in the event of a breach by one party. Article 184(2) requires that “the terms of the contract are explicit in demonstrating that it is the will of the parties”. In other words, unless the language of the contract clearly states the parties’ intention to permit termination of the contract by notice, the termination will be unlawful without a court order giving effect to the termination. Based on the foregoing, contracting parties should give careful consideration when drafting termination provisions to avoid exposing the terminating party to claims for compensation as well as placing it in the invidious position of being in breach for non-performance of their contractual obligations.

In addition to the aforementioned termination rights, a contracting party may also terminate a construction contract under Article 704 if “the agreed work is impossible to perform due to a foreign cause beyond the control of either party”. In such event, the employer may be liable to the contractor for costs incurred (including wages) within the scope of the benefit obtained by the employer from such work. It is important to emphasise that work will need to be “impossible” to perform rather than onerous. To avoid any ambiguity and mitigate the risk of disputes, it is in the parties’ best interests that force majeure is clearly defined in the contract and that compensation is agreed at the outset as it may be difficult to objectively measure the scope of the benefit obtained by the employer.

Finally, a contractor may have a right to suspend the contract under Article 191, which provides as follows “…if the corresponding obligations are outstanding, either party may decline to perform its own obligation unless the other party performs its own obligation, unless the parties agree otherwise or unless the practice provides otherwise”. What this could mean (in theory at least) is that unless it is otherwise agreed between the parties, the contractor may refrain from performing its obligations in the event that an employer fails to certify, or pay, sums due to the main contractor for works already carried out under a contract. However, suspension is a difficult right to enforce in practice as it is likely to require a substantial failure of performance by the other party before it can be relied upon.

CONCLUSION

Relying exclusively on the Qatar Civil Code for the ability to suspend work or terminate a contract is a risky strategy. It is not uncommon for parties to incorrectly assume that they have a right to suspend or terminate in a particular situation and to purport to suspend or terminate the contract without any legal right to do so. This can result in the suspension or termination being ineffective and the party seeking to rely on such rights being exposed to a damages claim. The risk of unlawful suspension or termination can be mitigated in large part by setting out clearly in the contract the specific circumstances in which rights of suspension and/or termination may be invoked and the procedures that need to be followed. This will give the parties greater confidence in the termination process and avoid the requirement of having to obtain a court order to bring the contract to an end.

Reform of construction contract law planned in Germany

Posted in Articles and Publications, Europe

By Christoph Mank, K&L Gates, Berlin

Introduction:

Despite the huge economic significance of the construction industry to Germany, there is, as yet, no codified construction contract law. Usually, general services contract law according to the German Civil Code (Bürgerliches Gesetzbuch – BGB) is applied to contract types as varied as manual repair work and project developments involving millions of Euros. Traditionally, general contractual terms known as “VOB/B” (Verdingungsordnung für Bauleistungen), which have existed for almost 100 years, are of considerable practical importance to the German construction industry. They are flanked by increasingly extensive case law regarding individual issues of construction law, requiring expert knowledge to comprehend the legal framework for construction contracts. A codification of construction contract law has been called for in Germany for a long time. The most recent comprehensive reworking of the law of obligations, which came into effect in 2002, also saw a revision of services contract law, but without consideration of the specific characteristics of construction contracts. The pressure exerted by practitioners on the legislature has increased due to recommendations issued by the building commission, “Deutscher Baugerichtstag”, that has been convening biannually since 2006. In September of this year, a draft bill was presented by the Federal Ministry of Justice and Consumer Protection (Bundesministerium der Justiz und für Verbraucherschutz) for the reform of the construction contract law. There will be considerable need for further discussion regarding the details in the consultations currently taking place among interested groups. However, we would like to take this opportunity to give an overview of the planned changes to the law.

Overview:

The justification for the draft reveals that there are two fundamental factors driving the draft bill. On the one hand, there is the lack of consumer protection rules whatsoever in services contract law, unlike in other fields of law significant to consumers. On the other hand, a recent ruling by the European Court of Justice [cf. judgment of 16 June 2011 – C 6509 and C 87/09] has led the German legislature to believe that changes to the liability for defects under sales law are required in order to allow service providers who purchased and installed defective building materials a more comprehensive recourse to suppliers than hitherto possible under German law. Against this background, the legislature has decided not only to modify the liability for defects under sales law and special provisions for the so-called consumer construction contract (Verbraucherbauvertrag), but also to include separate clauses and subclauses for construction contract, the agreements with architects and engineers, as well as construction contracts in the services contract law of the German Civil Code.

Key modifications:

  • The clause concerning the construction contract will include an explicit instruction right (Anordnungsrecht) for the purchaser (Besteller) that can be enforced under facilitated conditions by means of a temporary injunction in cases where a dispute arises after construction has begun.
  • The purchaser’s instruction right corresponds to an adjustment of the contractor’s reimbursement that shall be primarily determined on the basis of the costs that are actually necessary, with the contractor being able to fall back on a previously specified calculation, though it would not be compelled to do so.
  • The termination of a construction contract must be made in writing.
  • The safety of the construction workers according to § 648a of the German Civil Code shall be limited to 20% of the agreed remuneration in the case of partial payments agreed in line with the usual practice.
  • The obligations normally contained in such a contract will now be legally determined in the subtitle concerning the architects’ and engineers’ agreement. In addition to this, the draft bill introduces a project concretisation phase (Projektkonkretisierungsphase), during which the architect will initially owe the services necessary for the achievement of the planning and monitoring objectives; a contract for the complete architecture (Vollarchitektur) is not possible until these objectives have been achieved.
  • Furthermore, proposed legislation provides that, if the architect is jointly and severally liable towards the contractor for defects, the architect’s liability does not take effect until a deadline for rectification issued by the purchaser to the contractor has passed in vain.
  • In addition to this, a clause concerning the consumer construction contract will be introduced that specifically lays down comprehensive consumer information obligations, such as a building description with defined minimum content, but also a legal foundation for a security retention amount (Sicherheitseinbehalt).

Due to the extensive proposals for reform, it is to be expected that the discussion of the draft bill with the associations concerned will take some time; it cannot, therefore, be said with certainty when the Ministry of Justice’s draft bill will come into effect, or what the final version will look like.

New Jersey Appellate Court Holds That Coverage Exists for Consequential Damages Caused By Subcontractors’ Defective Work

Posted in Uncategorized

By Denise N. Yasinow, Loly G. Tor, and Christopher A. Barbarisi, K&L Gates, Newark

This past summer, the Superior Court of New Jersey, Appellate Division issued a favorable decision for owners, real estate developers, and general contractors regarding insurance coverage for damages caused by the faulty work of their subcontractors.  In Cypress Point Condominium Association, Inc. v. Adria Towers, LLC,[1] the Court held that unexpected and unintended consequential damages caused by a subcontractor’s defective work constitutes “property damage” caused by an “occurrence” under a commercial general liability (“CGL”) insurance policy.  Thus, these types of consequential damages are recoverable.

The Cypress Point decision roundly rejected the Third Circuit’s opinion in Pennsylvania National Mutual Casualty Insurance Co. v. Parkshore Development Corp.,[2] which concluded that faulty workmanship performed by a contractor or a subcontractor that causes damage to the general contractor’s work is not an “occurrence.”

In Cypress Point, the plaintiff, a condominium association, brought an action against the association’s developer, the developer’s two insurers, and various subcontractors.  The developer served as the general contractor on the condominium project and hired the subcontractors to perform all construction work.  The plaintiff sought coverage from the insurers under the developer’s CGL policies for consequential damages caused by the subcontractors’ defective work.  According to the plaintiff, the subcontractors improperly installed the roof, flashing, gutters and leaders, brick and EIFS facade, windows, doors, and sealants.  The faulty workmanship caused consequential damages to the common areas of the condominium complex and to the unit owners’ property.

The trial court granted summary judgment to one insurer and dismissed the complaint against the other insurer as moot, determining that there was no “property damage” or “occurrence” as required by the policy to trigger coverage.

On appeal, the plaintiff raised two main arguments.  First, the plaintiff argued that under a plain reading of the policy language, consequential damages constitute “property damage” and an “occurrence.”  Second, the plaintiff argued that the trial judge erroneously placed substantial reliance on the holdings in Weedo v. Stone–E–Brick, Inc., 81 N.J. 233 (1979) and Firemen’s Insurance Co. of Newark v. National Union Fire Insurance Co., 387 N.J. Super. 434 (App. Div. 2006) to determine whether there existed “property damage” and an “occurrence.”

On the first argument, the Cypress Point Court found that consequential damages constitute “property damage” and an “occurrence” as defined in the policy.  On the second argument, the Court concluded that the trial judge erroneously applied the holdings in Weedo and Firemen’s and readily distinguished the cases on two grounds.  First, the Court concluded that Weedo and Firemen’s involved only replacement costs of correcting the defective work itself (cost of replacing stucco in Weedo and replacing firewalls in Firemen’s) rather than the costs of curing consequential damages caused by defective work.  Second, the Court concluded that Weedo and Firemen’s interpreted different language than the policy language at issue in Cypress Point.

Indeed, the policies in Weedo and Firemen’s followed the Insurance Services Office, Inc.’s (“ISO”) 1973 standard CGL form (the “1973 ISO form”) whereas the policy in Cypress Point followed the 1986 standard CGL form (the “1986 ISO form”).  The Court found that there are two critical differences between the 1973 ISO form and the 1986 ISO form.  First, “occurrence” is defined differently.  Second, and most importantly, the 1986 ISO form includes a significant exception for subcontractors in the “Your Work” exclusion, which states: “[t]his exclusion does not apply if the damaged work or the work out of which the damage arises was performed on your behalf by a subcontractor.”  The 1973 ISO form contains no subcontractor exception to the “Your Work” exclusion.  As such, the Court found that the subcontractor exception demonstrates that consequential damages caused by a subcontractor’s faulty workmanship are considered differently than property damage caused by a general contractor’s work.  Therefore, a developer would “reasonably expect that consequential damages caused by the subcontractors’ faulty workmanship constituted ‘property damage’ caused by an ‘occurrence.’”

The Cypress Point decision is significant to policyholders, as New Jersey has joined the current majority of states holding that defective construction work causing consequential damages gives rise to an “occurrence” and “property damage.”  Furthermore, as long as the policies at issue follow the 1986 ISO form rather than the 1973 ISO form, there is a strong argument under New Jersey law that consequential damages from defective work performed by a subcontractor are always recoverable by additional insureds, such as the general contractor, the developer, and/or the owner.


[1] 441 N.J. Super. 369 (App. Div. 2015)

[2] 403 F. App’x 770, 772 (3d Cir. 2010)

Materials Available: EPC Contracting Issues in the Oil & Gas Industry

Posted in Asia Pacific, Europe, Industry Events, Middle East, The Americas

K&L Gates and Marsh recently co-sponsored a one-day, complimentary seminar titled “EPC Contracting Issues in the Oil & Gas Industry.”

The seminar featured six hour-long sessions, including a luncheon presentation by Robert Peterson, senior partner at Oliver Wyman, and an industry roundtable review panel consisting of industry experts from Exxon Mobil, Phillips 66, Chicago Bridge & Iron Company, Fluor, and Aker Solutions.

More than 100 representatives from leading energy companies attended the seminar at the JW Marriott Houston Downtown.

Houston partners Randel Young and John Sullivan III, Pittsburgh partners Richard Paciaroni and Jason Richey, London partner Matthew Smith, Washington, D.C. partner Steven Sparling, and Dallas partner Beth Petronio, along with Pittsburgh associate Jackie Celender, presented during the seminar.

Seminar materials can be found here.

Materials Available: 2015 Legal Update – Construction and Engineering Seminar

Posted in Articles and Publications, Europe, Industry Events

On 7 October 2015, the K&L Gates London office held a 2015 Legal Update – Construction and Engineering breakfast seminar.  The seminar featured the following topics:

  • CDM 2015: The End of the Transition – Nicola Ellis, Special Counsel
    The Construction (Design and Management) Regulations 2015 came into force on 6 April. This session highlights the key changes that were introduced, the practical effects of those changes and the consequences of the transitional provisions coming to an end on 6 October.
  • Construction Law UpdateInga Hall, Special Counsel
    A summary of some of the recent key construction and engineering cases that have come before the courts, and the implications of those decisions.
  • The NEC3 Suite: Beyond the ECC – Matthew Smith, Partner
    This session looks at the true range of options the NEC3 suite of contracts offers and gives an insight into which issues are addressed consistently across the suite, and highlights the key differences between specific forms.

To view a copy of the materials from this seminar,  please click here.

Update on Legal Advice Privilege

Posted in Articles and Publications, Europe

By Mike R. Stewart and Nita Mistry, K&L Gates London

In common law jurisdictions, legal professional privilege prevents communications between a professional legal adviser and their clients from being disclosed.  There are two main types of privilege:

  • Legal advice privilege, which protects confidential communications between lawyers and their clients; and
  • Litigation privilege, which protects confidential communications, provided that such communications have been created for the dominant purpose of obtaining legal advice for litigation.

This update focuses on recent developments concerning legal advice privilege .

The current position (in English Law) is that legal advice privilege protects:

  • The confidentiality of communications;
  • Between lawyers and client;
  • Created for the purpose of giving or receiving legal advice;
  • Regardless of whether litigation is pending or contemplated.

In 2003, the English Court of Appeal sought to limit the meaning of a corporate client in the context of legal advice privilege. The key case is that of Three Rivers District Council v Governor and Company of the Bank of England (No 5) [2003] QB 1556 (Three Rivers (No 5)). In this case, the Court of Appeal took a restrictive interpretation of the meaning of a “client” when determining if communications were privileged.  It follows that, as a matter of English law:

  • Not all employees are considered to be the “client”.
  • In the case of individuals, the client is the individual instructing the lawyer.
  • In the case of a corporate entity, the client is those employees of an organisation responsible for communicating with the legal advisers.

The Three Rivers decision has caused difficulties for corporate entities.  Some employees may not be considered part of the “client” for the purposes of legal advice privilege.  This means that communications or documents prepared by those employees will not be privileged.

Even a communication or document that is prepared by one employee to enable another employee to seek legal advice from a lawyer will not be privileged (unless the communication or document that is prepared is for the purpose of contemplated litigation).  In considering whether communications and documents are protected by legal advice privilege, it must be determined who within the company is the “client” instructing the lawyer.

Hong Kong Court of Appeal in Citic Pacific Limited v Secretary for Justice and Commissioner of Police (29/06/2015, CACV 7/2012)

In a significant judgment, the Hong Kong Court of Appeal (HKCA) has departed from English law adopting a wider test for the application of legal advice privilege.

First Instance Decision

Citic Pacific Limited (the “Company”) was being investigated by the regulatory authorities in relation to a profit warning announcement.  The company made a claim to privilege in respect of a large number of documents and other material seized by the police.

The judge held that some of the documents seized did not attract legal advice privilege because they were communications between certain of the company’s employees which were not communications on behalf of the company.

The Hong Kong Court of Appeal

The HKCA was asked to determine:

  • Whether the first instance judge was correct to decide that privilege was limited to direct communications between those in the group legal department and its external lawyers;
  • Whether Three Rivers (No 5) was good law in Hong Kong; and
  • The proper approach to the definition of a “client” for the purpose of legal advice privilege.

The HKCA rejected the restrictive view adopted by both the first instance judge in Citic Pacific and the English Court of Appeal in Three Rivers (No 5).  The court held that:

“In the context of a corporation, where the necessary information may have to be acquired by the management from employees in different departments or at various levels of the corporate structure, there is a need to protect the process of gathering such information for the purpose of getting legal advice…it is unlikely that a small group of employees within the legal department of a corporation would be likely to have all the technical knowledge or skills that may be required to obtain information for, and put together, suitable instructions to the corporation’s lawyers”.

The HKCA adopts a wider test for the application of legal advice privilege. The “client” is simply the corporation as a whole.  All employees within the corporation are considered the “client”.

The question is which employees should be regarded as being authorised to act for it in the process of obtaining legal advice.  The HKCA adopted a “dominant purpose” test for this.  It is only internal confidential documents or communications, prepared by an employee for the dominant purpose that they be used to obtain legal advice, that will be protected by legal advice privilege.

In summary, legal advice privilege under Hong Kong law now extends to confidential internal communication:

  • between employees of a client organisation, provided that
  • those communications were created for the sole or dominant purpose of obtaining legal advice.

The Future for English law?

Three Rivers (No 5) still remains binding under English law and has not been overruled.

The dominant purpose test does not apply to English law in the context of legal advice privilege.

The position may be challenged in the future in light of the more liberal approach taken in Hong Kong and other common law jurisdictions.

Illinois Now Allows Bonding Off of Mechanics Liens on Private Projects

Posted in Articles and Publications, The Americas

By Jesse G. Shallcross, K&L Gates, Chicago

On July 29, 2015, Illinois Governor Bruce Rauner signed into law an amendment to the Illinois Mechanics Lien Act which allows a property owner, contractor or other party with an interest in real property which is subject to a mechanics lien claim filed against the property by an aggrieved contractor, subcontractor or material supplier on a private project to substitute a surety bond for such mechanics lien claim.[1]  The new law is scheduled to take effect on January 1, 2016.

Illinois now joins the ranks of no less than 35 other states that provide for the right of an interested party to substitute a surety bond for real property against which a mechanics lien claim is filed, also known as “bonding off” a mechanics lien claim, on private projects.

Under the new law, (i) at any time, such interested party (referred to in the statute as an “applicant”) may file a petition with the county where the property is located to bond off a mechanics lien claim filed against the property, or (ii) if there is already a pending court action to enforce a lien claim, the applicant may, within five months after the filing of the complaint, apply to become a party thereto and file a petition to bond off the lien claim.  The bond must be issued by an A-rated surety company in an amount equal to 175% of the claim.

Bonding off a mechanics lien claim allows the property owner or other party having an interest in the property to substitute the claimant’s lien on the property with a guaranty of a surety to provide a sum of money to the claimant if the claimant is successful in his claim.  This is generally beneficial to owners, developers, general contractors and the like, as they are free to forge ahead on a construction project without being hamstrung by pesky subcontractor liens encumbering the property.

However, the new law also benefits aggrieved contractors, subcontractors and suppliers, particularly those who would prevail in court.  The bond is required to be issued in the amount of 175% of the claim amount, and the law explicitly grants the prevailing party an award for attorney’s fees.  Additionally, and perhaps most importantly, substituting a surety bond for a lien on real estate allows a successful claimant to collect on a judgment without potentially having to wait for a final disposition of the property, which may be subject to the security interests and liens of other creditors.

The new amendment to the Mechanics Lien Act does not apply to public projects, as Illinois does not allow mechanics liens to attach to real property owned by the state to begin with.  With respect to private projects, however, there is no such prohibition against mechanics liens but rather a statutory right granted to aggrieved contractors, subcontractors and suppliers under the Act.  Therefore, an amendment to the Act was required to allow a property owner, contractor or other interested party to override this statutory right and bond off a mechanic’s lien.

The law was the culmination of two-and-a-half years of efforts involving multiple parties, spearheaded by Paul Peterson of Chicago Title Insurance Company.  The bill was drafted by the Chicago Bar Association and co-sponsored by the Illinois State Bar Association and Illinois Land Title Association.


 

[1] See Public Act 099-0178; 770 ILCS 60/38.1