Risk Allocation In Construction Projects

July 2002

by Eileen M. Diepenbrock, Esq., Diepenbrock Harrison

Jay C. Davison, AIA, Capital Program Management, Inc.

William A. Lichtig, McDonough, Holland & Allen

Steven P. Rudolph, Folsom City Attorney

1. INTRODUCTION

Methods of restricting liability or allocating risk are important to any construction project. Although many methods have been attempted, courts and legislatures have limited their application in certain instances. This presentation examines the enforceability and/or restrictions on various methods of attempted risk allocation and liability. These methods include allocating the risk for (1) design errors; (2) unexpected site conditions; (3) construction errors and delays; and (4) risks of payment.

2. ALLOCATING RISKS OF DESIGN ERRORS

(a) The Dilemma for the Construction Owner: Implied Warranty of the Plans and Specifications vs. Professional Negligence Standard.

When an owner furnishes plans and specifications for a construction project, the owner generally bears responsibility for any deficiencies in those specifications. That is, the owner impliedly warrants the correctness of those plans and specifications; i.e., that the project can be constructed based on the plans and specifications. See Souza & McCue Const. Co. v. Superior Court, 57 Cal.2d 508 (1962). This concept is also reflected in what has been called the Spearin Doctrine, arising out of the U.S. Supreme Court’s holding in United States v. Spearin, 248 U.S. 132, 135 (U.S. 1918). In that case, the Court held that a contractor is bound to build according to plans and specifications provided to it by the owner, and if the contractor does so it will not be responsible for the consequence of defects in the plans and specifications. As a consequence of the implied warranties, when the plans and specifications are defective and cause a contractor to engage in extra work and expenses not anticipated when entering into the construction contract, the contractor is able to recover for the extra work and expenses. See Souza & McCue Const. Co., 57 Cal.2d 508. The measure of damages for the contractor is the usually the increased cost of time and materials necessary to overcome the problems caused by the defective plans and specifications.

A design professional usually provides no warranty that a project will perform in a particular way, and can therefore only be held responsible for errors in the plans and specifications that are a manifest result of a breach of contract or professional negligence. Negligence is defined as conduct falling below the standard established by law for the protection of others against unreasonable risk of harm. Flowers v. Torrance Memorial Hospital Medical Center, 8 Cal. 4th 992, 997 (1994). Thus, the standard for professionals is articulated in terms of exercising ‘the knowledge, skill and care ordinarily possessed and employed by members of the profession in good standing ....’ Id. at 998 (quoting Prosser & Keeton, Torts (5th ed. 1984) The Reasonable Person, § 32, p. 187.) In order for an owner to hold a design professional responsible for any errors in the plans and specifications, the owner must establish that the design professional failed to exercise the same degree of care, skill, and proficiency competently exercised by ordinarily careful and prudent design professionals. This standard is more difficult to prove than “ordinary” negligence because it often requires expert testimony regarding the knowledge and skill of a competent professional.

Therefore, when the plans and specifications contain some defect, an owner is faced with a dilemma. The owner is responsible to the contractor for providing those specifications, under the theory of implied warranties of correctness, yet the owner may encounter difficulty proving any liability on the part of the design professional. Accordingly, it is important to consider this dilemma at the outset of a construction project and contractually allocate risks of design errors to both the contractor and the design professional where possible.

(b) The Dilemma for the A-E: Constraints on Fee as They Relate to Ability to Produce High-Quality Documents

How are A-E fees established? As with most types of professional fees, they are “negotiated.” Also as with most professional fees, they are guided by certain standards within the industry. These standards were at one time published by the professional organizations, but the courts determined that this constituted restraint of trade, and they are no longer published.

However, public agencies often publish allowable fee scales for certain types of projects. For example, the State Office of Public School Construction until 1998 published scales of allowable architect fees for state-funded school construction and modernization. These fee scales were developed in the mid-1980’s and in effect became the industry-standard fees for school design; for all practical purposes they remain so today.

The difficulty that arises is that school construction has become increasingly complex, both from a regulatory and a technological standpoint. An increasing number of subspecialties are required as instructional technology becomes more complex, toxics requirements become more complex, energy requirements become more complex, “green” architecture gains momentum, and Americans with Disabilities Act compliance becomes increasingly well-defined. Each of these areas has become a specialty onto itself, adding to the list of consultants included in the design team.

A construction atmosphere perceived as increasingly litigious has also put pressure on the A-E team. Peer reviews of completed documents are increasingly commonplace. Construction management firms have made major inroads into public agency construction, often adding to the design team’s workload in ways not anticipated.

All of these increasing requirements have come to the design team without corresponding increases in fee scales. Although the OPSC abandoned its fee scale with the passage of Proposition 1A in 1998, which converted school construction funding into a grant program, the old scales still are used by most school districts and architects as the starting point for negotiations (with architects viewing them as the floor, and districts viewing them as the ceiling). The result of all this is increasing pressure on profits, and firms have had to adjust their operations to compensate.

Profitability of A-E firms is typically not very high. The American Institute of Architects collects data on this subject, and its information reflects an average profit margin of less than 5% for architectural firms. Since the large majority of costs in A-E firms is employee salaries, low profitability also puts pressure on salaries. As a result, architects are historically among the lowest paid professionals, often earning much less than the skilled trade workers who are implementing their designs. The recession of the early 90’s caused many architects to leave the professions, and this left a labor shortage when the building boom of the late 90’s hit. The resultant upward pressure on salaries (architects for the first time in anyone’s memory were being offered signing bonuses by some firms) squeezed the profit picture even further.

As a for-profit business, an architectural firm has only a couple of options to respond to increasing costs and decreasing profitability: it can increase fees or cut production costs. If fee increases are not an option, the firm must find ways to produce its product (the construction documents) at less cost. Again, there are two options to accomplish this: produce the documents more quickly, so that individual architects can be more productive, or use lower paid (and usually less skilled) individuals to produce them. Either approach is likely to result in less accurate and less complete construction documents, which is exactly what most construction professionals and owners are complaining about today.

Would an increase in fees help this situation? It couldn’t hurt, but it might not be a panacea. Most A-E firm owners in California today complain about the difficulty they have recruiting qualified design professionals. Low starting salaries have made the design professions less attractive to entry-level graduates, and the increase in demand has not been matched by a concomitant increase in the skilled labor force. If firms responded to fee increases by reducing the number of projects they undertook, allowing each project to receive more attention from the senior level design professionals, quality of design documents might indeed increase; but it is not absolutely clear that the firms would respond in that way.

(c) Level of Completeness Required for Design Documents Pre-Bid: What is Shown, What is Implied Intent, and What is Good Enough

Has the thoroughness, level of completeness, and quality of design documents changed over the years? This seems to be a subject of unending debate among design and construction professionals. Contractors often complain that the design documents they get nowadays are not nearly as good as in “the old days.” Design professionals often complain that they can’t depend on contractors to adhere to the standards of the trades like they used to, so every little thing has to be shown or specified in order to ensure a level of quality that used to be assumed.

On a recent set of school renovation projects, we had the unique experience of renovating a pair of high schools originally built in the early 1960’s from the same set of plans. The same design team prepared construction documents for the renovation of the two high schools, which were then bid separately and awarded to two different contractors. One of the projects had several hundred thousand dollars in change order requests from the contractor due to “errors and omissions” in the documents, while the other had virtually none. So where does the problem lie?

Design professionals are now being advised by both their insurance carriers and their professional associations to show and specify an item only once, i.e., in one location on the drawings. This is intended to reduce confusion by eliminating the possibility of missing a change in a detail that is shown in several locations or versions. The result of this advice is twofold: first, it often makes details harder to find and reference. Second, it increase the use of “sim.” on the drawings, which may lead to frustration on the part of the skilled tradesperson who finds the actual situation is not quite as similar as the detail implies.

For the design professional, striking the balance between too much and too little detail in the documents can be a hazardous exercise. Too little detail shifts the burden to the contractor and its craftspeople to figure out how the thing should be built. Too much detail introduces more opportunities for conflict and error, besides taking more production time and, in the case of renovation, more thorough site investigation. Some design firms are incorporating digital photography of existing conditions into their renovation drawings; such photographs can often be annotated directly on the photo, saving drafting time.

One of the more controversial subjects in our profession is the meaning of the phrase “design intent.” Construction documents are supposed to be the vehicle by which the designers communicate their intent to the workers who will actually turn that intent into reality. The problem arises when the designers are not able to communicate perfectly or completely, and the trades workers are unable to read the designers’ minds. A-E agreements typically refer to the right and duty of the designer to issue supplemental drawings and other information to clarify his intent; the implicit assumption is that this clarification will not result in extra cost. But the contractor does not always agree with that assumption.

Something that appears more often in present-day document is language to the effect that the intent is to have a “complete and operating system.” This is directly related to the too much/too little detail questions, and is a result of designer’s frustration over being asked to pay extra for a required component that should have been obvious was a necessary part of a system. Contractors complain that this language shifts responsibility to them to make sure that all of the components are included and compatible. Designers point to specialty contractors as the true experts in the various systems, and this whole issue gets back to the increasing complexity of building systems today and the inability of designers to be experts in all of the areas of complexity.

“Customs and standards of the trades” is another archaic expression often cited by attorneys and older design professionals, harkening back to the days of yore when men were men, women were women, and trades workers took pride in their work. As long as there was only a narrow range of options for certain systems and finishes, customs and standards was a fairly reliable idea. But almost every component of a building can now be produced in a wide variety of ways. Both designers and installers are increasingly dependent on manufacturer’s recommendations, both to ensure that warranties are not compromised and to ensure that the component or system will perform in the way it was intended to. This is another area with broad potential for conflict between design teams and contractor/installers. In order to remain competitive, contractors are always looking for ways to perform work faster (labor being the major cost for them). New materials and systems look attractive to a contractor if they promise easier installation and fewer callbacks. For the designer, “tried and true” is usually the safer route. The construction industry historically is full of examples of materials and systems that did not live up to their initial promise, and left the owners of these innovative buildings stuck with bills for replacement of the defective components.

(d) Constructability (Peer) Reviews as a Method for Improving Quality of Documents

In recent years the “constructability review” has played an increasingly prominent role in the design process. Originally used by the construction management industry as an entrée into a client’s graces, constructability review has now become a thriving cottage industry by itself. What is it, and does it offer promise in improving the quality of construction documents?

The term “constructability review” is an unfortunate one, because constructability is not usually what is being reviewed. There are several types of review that can be conducted on a set of design documents:

(i) Coordination, conflict, and completeness (QC) – are the various consultant documents coordinated with each other and with the architectural drawings; are there conflicts among the drawings and between the drawings and specifications; are detail references correct; are the documents complete? This is the most common type of review that is sold under the general title of “constructability review”.

(ii) Code compliance – do the documents comply with all applicable building, fire, access, and other codes?

(iii) Program compliance – do the documents address all of the items in the architectural program?

(iv) Standards compliance – do the documents adhere to the owner’s design or facility standards?

(v) Constructability – can the building be reasonable built based on the “instructions” provided by the documents?

(vi) Value engineering – are there alternate systems or materials that will provide similar results at less cost?

Several important questions need to be addressed with respect to the subject of document review. The first and foremost is: when should it be done and who should do it? This may be different depending on the type of review that is actually desired. Some basic suggestions are:

(i) QC review – should be done when documents are as nearly complete as possible in order to avoid duplication with the design team’s normal QC effort. This will mean delay of the bid, so review time should be factored into the schedule. A QC review should ideally be conducted as a peer review by another design professional, since they will have the best understanding of how construction documents are put together.

(ii) Code compliance – should be done early in design development, when detail design and layout decisions are being made. It will need to be followed up in the finished documents. A code compliance review should be done either by another design professional or an individual trained in code enforcement such as a licensed inspector.

(iii) Program compliance – should be done at the end of design development, ideally by the individual who developed the program.

(iv) Standards compliance – should be done during construction document phase, after the specifications are reasonably well developed. Should ideally be done by the author of the standards or the individual departments within the client organization that helped develop the standards.

(v) Constructability review – should be conducted during construction document phase after the specifications and most details are reasonably well developed. Should ideally be done by a contractor or other construction professional with actual “hands-on” experience.

(vi) Value engineering – should be conducted early and throughout design, ideally by a certified value engineering professional.

One of the stickier issues about reviews is the incorporation of the reviewer’s suggestions into the documents by the designer. It is important for the owner that the designer retains design responsibility (and liability) during the process. This may mean that not all the suggestions are followed, (that being the designer’s prerogative), but they should all be addressed in some fashion. It is best if the owner-A-E contract addresses this issue, so that all parties understand that a review will be conducted and that there is an expectation that all of the items in the review will be addressed. Absent such language in the original agreement, some firms may consider this to be an extra service, and will want to be compensated accordingly.

Owners should consider an independent review to ensure that the design team has indeed incorporated or addressed all of the comments. This is because a “constructability” review could create liability for the owner in a contractor claim situation if errors in the documents were documented (and therefore known to the owner) but not corrected. For many of the reasons discussed previously, design professionals may not be 100% diligent in addressing all the items documented in a review. This is also a good argument for requiring that the review itself be documented in a simple, tabular form that provides space for the design professional’s response.

Are QC and other reviews worth the cost? They are not inexpensive. A rule of thumb for the effort required for a reasonably complete QC review is 1.5 to 2 hours of reviewer time per sheet of drawings, and 20 to 30 minutes per page of specifications. Depending on the hourly rate of the reviewer, this could generate significant cost. (As a comparison, a rule of thumb for the original production of the drawings is 20 to 40 hours per sheet). No review will come close to catching all of the errors in the documents. Notwithstanding these concerns, we believe a review will virtually always pay for itself. Even if a QC review cost $20,000 for a set of documents for a $5,000,000 project, a relatively minor change order could easily exceed that amount.

(e) Shifting the Risk of Design Errors to the Contractor

(i) Pre-Bid Review of Construction Documents

While the owner impliedly warrants the adequacy and sufficiency of the construction plans and specifications, contractors may find themselves liable for design problems by failing to carefully review and compare the contract documents. Contractors have a duty to review the construction documents before submitting their bids to identify “patent,” or obvious errors, in the contract documents. Implicit within the duty to review the documents prior to bidding is the contractor’s duty to seek clarification of any patent ambiguities it discovers while reviewing the construction documents. Damages resulting from the contractor’s failure to notify the architect or owner of any patent errors, inconsistencies, omissions, and variances within the contract documents become the contractor’s responsibility, not the owner’s.

But what standards do courts apply in determining whether the contractor should have discovered the design deficiency pre-bid? One of the leading cases summarized the contractor’s obligations as follows:

[C]ontractors are business men, and in the business of bidding on Government contracts they are usually pressed for time and are consciously seeking to underbid a number of competitors. Consequently, they estimate only on those costs which they feel the contract terms will permit the Government to insist upon in the way of performance. They are obligated to bring to the Government’s attention major discrepancies or errors which they detect in the specifications or drawings, or else fail to do so at their peril. But they are not expected to exercise clairvoyance in spotting hidden ambiguities in the bid documents, and they are protected if they innocently construe in their favor an ambiguity equally susceptible to another construction, for . . . the basic precept is that ambiguities in contracts drawn by the Government are construed against the drafter. In the case before us the ambiguity was subtle, not blatant; the contract.

Blount Bros. Construction Co. v. United States, 346 F.2d 962,973 (Ct. Cl. 1965)

Before the contractor will be found responsible for failing to raise a design deficiency pre-bid, it must be established that the error was sufficiently apparent that a reasonable business person would have recognized it. Again, this determination is made based upon the position of the contractor while bidding the project. Interpretations arrived at during construction and based upon complex interrelationships in the specifications will not be persuasive. See, e.g., Gorn Corp. v. U.S., 424 F.2d 588, 592 (Ct. Cl. 1970) (“We suspect that the Government attorneys themselves used hindsight and devoted many hours of Monday morning quarterbacking to come up with their circuitous cross-checking solutions.”)

In assessing whether an ambiguity is substantial or obvious, courts rely on a number of factors, including the following:

· Dollar value of the disputed work as compared to the entire project

· Conduct of other bidders during the bidding period

· Importance of the disputed work to the entire contract requirements

· The ease with which the government could have stated its desires more clearly.

Ultimately, the contractor should be held to a standard of reasonableness. While the design team will have had months, and perhaps years, to prepare accurate and complete contract documents, the contractor will usually only have a matter of days to prepare its estimate. As stated by one court:

[a] contractor should not be required to wade through a maze of numbers, catalogues, cross-reference tables and other data resembling crossword puzzles in order to find out what the government requires in an invitation for bids. This is especially true where, as in this case, the requirements of the government could have been clearly specified by the use of a half dozen ordinary words and figures.

Gorn Corp. v. United States, 424 F.2d 588, 592 (Ct. Cl. 1970).

In addition to the obligation to disclose patent defects and seek pre-bid clarification, most construction contracts contain pre-bid site investigation clauses that require contractors to visit the site prior to submitting a bid. A common site investigation clause generally provides:

The bidder shall examine carefully the site of the work contemplated, the plans and specifications, and the proposal and contract forms therefor. The submission of a bid shall be conclusive evidence that the bidder has investigated and is satisfied as to the conditions to be encountered, as to the character, quality, and scope of work to be performed, the quantities of materials to be furnished, and as to the requirements of the proposal, plans, specifications, and the contract.

See Caltrans Standard Specifications, § 2-1.03.

Bid solicitations may also require contractors to review documents concerning the site conditions that are made available for inspection prior to bidding, but are not necessarily included in the contract documents. As with the site investigation itself, contractors may be precluded from recovering for patent derivations, or the contractor may be liable to the owner for costs and damages that would have been avoided had the contractor investigated the site and reviewed the referenced documents. However, a contractor may reasonably rely upon extensive testing performed by the owner, despite a site investigation clause, when the results of such tests are made available to bidders and nothing about the site investigation would cause a reasonably prudent bidder to question the accuracy of the contract documents.

Risk for design errors can be further shifted to the contractor by including a contract provision that essentially makes the contractor the “guarantor” of the plans. These clauses attempt to bar contractors from making claims for delays or added costs caused by design defects. On California local agency public works contracts, however, these clauses have been prohibited. Public Contract Code § 1104 provides:

No local public entity, charter city, or charter county shall require a bidder to assume responsibility for the completeness and accuracy of architectural or engineering plans and specifications on public works projects, except on clearly designated design build projects. Nothing in this section shall be construed to prohibit a local public entity, charter city, or charter county from requiring a bidder to review architectural or engineering plans and specifications prior to submission of a bid, and report any errors and omission noted by the contractor to the architect or owner. The review by the contractor shall be confined to the contractor's capacity as a contractor, and not as a licensed design professional.

(ii) Coordination and Layout Drawings

On complex projects, the design team often defers the detailing of major systems and their components, leaving this responsibility instead to the trade contractors that will actually be performing the work. Mechanical, electrical and plumbing (“MEP”) drawings frequently show the ducts, pipe work, and conduit “diagrammatically,” with a single line representing a three-dimensional duct, for example, that may consume the majority of the space between the structure of the floor above and the ceiling below. The preparation of the coordination or layout drawings are the process by which each of the trades attempt to locate its work, and then confirm with the other trades that there are no conflicts among their various locations.

From the perspective of the trade contractors, particularly the mechanical contractor, the game is won or lost in the detailing and fabrication effort. The mechanical detailer must take the owner-provided diagrammatic drawings and convert these to production drawings which detail exact locations, routes, and sizes for the mechanical system. Once these detail drawings are complete, they are then overlaid with other MEP detail drawings for coordination. The coordination drawings are then submitted to the architect for approval. Once the drawings are approved, material fabrication can begin.

The coordination drawing process is intended to allow multiple contractors to decide how to install “ten pounds” of duct, conduit, and piping, within a “nine-and-one-half-pound” ceiling or wall cavity. When the trade contractors are unable to squeeze the necessary equipment within the available space, they request the involvement of the engineer to develop a solution. This typically results in relocation of architectural features (e.g., walls, ceilings, or lights), or redesign of the mechanical system itself.

Traditionally, the construction community recognized that it was the design teams’ responsibility to provide enough room in the ceiling or wall cavity to permit all of the trades to fit their specified work. In addition, the architect, along with its structural engineer, were responsible for ensuring that the routing of the MEP systems in accordance with the drawings would be workable. Recently, however, it is becoming more common for design professionals to seek to use contractor coordination and the preparation of layout drawings as a substitute for adequately coordinating the pre-bid work of the design consultants. While contractors should rightfully be expected to coordinate their work in an effort to confirm that their installations will not conflict with each other, the design team should maintain primary responsibility to confirm that the interstitial space will accommodate the systems that have been specified, and that the structural and architectural elements will not conflict with the trade installations depicted in the documents if constructed in accordance with the plans and specifications.

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