Wednesday, July 2, 2008

Back To Basics -- Managing Legal Risks And Liabilities

The Utah construction industry has had unprecedented growth and success over the past few years. Despite some ongoing positive things in Utah construction, there are some signs of slowing, particularly in the residential market.

In the good economic times, there is often a tendency to become lax in considering and managing legal risks. In such a positive market, it is often more profitable to worry about the next project rather than be concerned with the risks and potential problems on the current projects. However, in tight construction markets, such a lax attitude cannot continue because there are fewer projects and tighter margins.

Now is a good time to get back to the basics in managing the legal aspects of your business and construction projects. And, there is no better place to start than with your contracts. Even though your general contracts, subcontracts, supplier agreements, credit applications, etc. have served you well, over time they can get out of date as statutes change and can become disjointed as they are “tweaked” from time-to-time. One of the most common problems is that someone may borrow another company’s contract and implement it into their company without serious thought as to how it will work for their unique way of doing business. You should make sure that your contracts are consistent with your company’s goals and expectations and that the various risks are allocated according to those goals and expectations.

Financial risk can be managed, to a degree, through collection procedures and documentation. Although Utah law was changed with regard to lien waivers and restrictive endorsement, the majority of construction businesses still have not implemented the new requirements. If you issue checks with restrictive endorsement waivers and you have not changed the language to be consistent with the new statute, your restrictive endorsements will not be effective to waive mechanic’s lien rights. The new restrictive endorsement language can be found at Utah Code Annotated § 38-1-39(4)(d)

Insurance is another way to manage certain legal risks and liabilities on construction projects. However, most insurance companies exclude many of the risks from which construction industry participants need protection. These may include stucco, mold, and other important issues. These coverages can be negotiated back into insurance contracts but many construction industry participants do not know that such coverage is not routinely included. In addition, many do not understand even the basics of the insurance coverage they pay for. It is time to dust off that insurance policy and read it from beginning to end. More importantly, it is time to understand the coverage, negotiate with your insurance company for the additional coverage you require and to learn how to manage the risks for which you are unable to insure or for which coverage is too expensive.

It is time to get back to the basics of managing your legal risks and liabilities. These are just three important ways to get started with in that process.

Monday, June 9, 2008

Preserving the Economic Loss Doctrine in Utah for Everyone’s Benefit

The economic loss doctrine is something that most people in the construction industry know little or nothing about. However, it has been an essential part of the legal landscape governing claims on construction projects in Utah for many years. Its existence has prevented an unprecedented explosion of housing prices, particularly in multi-family housing. It has prevented an insurance crisis for construction companies, design professionals and others working in the construction industry. It has protected both purchasers of improved real estate and construction industry professionals. These problems, among others, have arisen in other states where the economic loss doctrine has been eroded or eliminated.

So, what is the economic loss doctrine? Unfortunately, it is somewhat technical and difficult to understand without a little legal background. Essentially, the economic loss doctrine is based in the distinction between contract claims (enforcing the standards negotiated and agreed to in contracts and usually applicable only the parties to those contracts) and tort claims (enforcing the standards that have been established by the courts or legislatures governing the behavior of all of us as members of society).

The following questions and answers should help to further clarify some of the major basic issues relating to the economic loss doctrine.

Q: What is the economic loss doctrine?

A: A court-developed legal principle that holds that purely economic damages arising from one party’s failure to perform as agreed by contract cannot be claimed and recovered via legal theory based in tort. Essentially, the economic loss doctrine precludes claims for negligent design or construction except through the contract under which the work was performed.

Q: What are economic damages?

A: “Damages for inadequate value, costs or repair and replacement of the defective product, or consequent loss of profits . . . as well as diminution in the value of the product because it is inferior in quality and does not work for the general purposes for which it was manufactured and sold.” American Towers Owners v. CCI Mechanical, 930 P.2d 1182, 1191 (Utah 1996). Economic damages are those that arise from poor design or construction. Claims in tort for damages arising from personal injury or physical damage to other property are not barred by the economic loss doctrine because they are not considered to be purely economic damages.

Q: What is the difference between contract and tort?

A: Contract law protects expectancy interests created through contractual agreements between the parties, while tort law protects individuals and their property from physical harm by imposing a duty of reasonable care. Expectancy interests arise from a contract between the parties to that contract and do not exist independently. Tort duties, on the other hand, are independent from any contract or agreement, and arise at law.

Q: Why have Utah courts adopted the economic loss doctrine?

A: The economic loss doctrine exists because of a policy determination that it would not be fair to allow a party to recover for “defective construction,” where the defects are defined by a tort-based legal standard that is higher than, or different from, the original contract between the parties. The contract alone defines the construction standards that will be imposed and any deviation from the agreed upon standards is a breach of the contract, but not a breach of any legal tort duty independent of the contract. Thus, liability for defective construction must be defined by the contract between the parties not by later claims that the builder has been negligent by not adhering to an amorphous standard that was never defined or agreed to by the parties to the contract. As long as the construction does not cause damage to people or property, the parties to a construction contract are free to agree to choose the lowest possible standards of construction. If the economic loss doctrine did not exist, design or construction professionals would remain liable to an indeterminate class of people for an indeterminate amount of time and for an indeterminate amount of money.

Q: Why does any of this matter?

A: If the economic loss doctrine were to be undermined in Utah, designers and builders could expect to regularly be sued by remote purchasers with whom the designer or builder had no legal relationship. These lawsuits would allege that the builder was negligent by not using certain construction techniques or by using certain materials, even though those techniques were not required by the contract, or in some situations would have been a breach of the contract. Such lawsuits would seek to impose standards that the builder never agreed to in the contract. Thus, if the economic loss doctrine were to be eliminated, courts would begin to formulate a “reasonable construction standard” that could be independent of contractual provisions or even building codes. Unfortunately, such a standard would be subjective and flexible, depending on each judge, and the outcome would depend to a certain extent on the effectiveness of the attorneys. This would typically become a problem in the context of homeowners associations suing designers and builders for construction defects throughout a development. Such suits in other states have created a pricing crisis for housing and an insurance crisis for everyone involved in the construction industry.

The economic loss doctrine is a court created rule that can be modified or even eliminated by the courts. In the 2008 general legislative session, the Utah legislature, recognizing recent attacks on the economic loss doctrine by enterprising attorneys, took action to codify the economic loss doctrine by enacting Senate Bill 220. This should insulate the economic loss doctrine from significant modifications or outright elimination by the Utah courts.

Importantly, Senate Bill 220 was not intended to change the current law but, rather, to preserve the economic loss doctrine as it has existed in Utah for many years. With Senate Bill 220 in place, the economic loss doctrine should continue to protect the public and construction industry professionals for the foreseeable future.