Five Reasons to Read the Dispute Resolution Clause in Your Construction Contract

Author: Corbin Devlin

Dispute resolution clauses are rarely the subject of negotiation. In my view, they are badly overlooked. Assuming that the construction contract in front of you proposes arbitration, what are some of the most basic, potential issues of concern?

Proceedings in a Distant Land
 
If your place of business is in Nisku, Alberta, do you want to have to travel to London, England or Abu Dhabi to resolve a payment dispute, because that’s where the contract says arbitration must take place?

The Other Guy Gets to Choose 
 
The unilateral right to appoint the decision maker is a tremendous advantage in any dispute resolution process. This is rare but not unheardof. Don’t ever agree to such a clause.

A Slow Arbitration Process
 
One of the key advantages to arbitration over litigation is the prospect of a quicker resolution. While this is usually true, some arbitration processes are not speedy at all. I was recently involved in an arbitration process that required four months of procedural steps prior to even appointing the arbitrator. If the dispute resolution process involves multiple steps, and each step is mandatory, and each step has a timeline associated with it, add up those steps and timelines to see if you can tolerate how long it might take to get to a decision. Some arbitration processes are almost as slow as litigation, and even more costly.

Unreasonable Timelines
 
A competing consideration is the reasonableness of the timelines. That is, timelines that are too short can also be problematic. In particular, avoid unreasonably short timelines for giving notice of a claim or dispute.

No Rules

Many dispute resolution clauses do not contain any rules for the process. For example:

• Will there be one arbitrator or three?
• What is the process for selecting the arbitrator(s)?
• Will there be questioning?
• Document disclosure?
• A full blown oral hearing with live witnesses?
• What are the rules of evidence?
• What are the timelines?

These rules matter greatly, in terms of how quick/fair, efficient/robust, simple/costly the process will be. If there are no rules prescribed, then be warned: there will be extra time and cost involved to negotiate and/or have the adjudicator establish the rules. 

Rules of arbitration are sometimes set out in the contract (or a schedule), but more often they are incorporated by reference. For example, a contract might simply make reference to the rules of dispute resolution published by an organization such as the Canadian Construction Documents Committee, the ADR Institute of Canada or the International Centre for Dispute Resolution. These rules vary significantly; all have pros and cons, and one set of rules might be perfect for one contract but wrong for another. The choice of rules deserves some advance thought. In my view, at the simplest, it is better to have any fair set of rules than to mandate arbitration without any rules at all. (Note: A clause that merely says arbitration will take place “in accordance with the Arbitration Act of Alberta” or something similar is still an arbitration clause without rules; the Arbitration Act deals with jurisdiction and rights of appeal… it does not set out rules for the arbitration process.)

Many Other Factors
 
There are a lot of other considerations that may be pros or cons depending on your perspective. Is the process final and binding? Is arbitration mandatory, or does the dispute go to arbitration only “if” the parties agree? Is non-binding mediation (and/or a progressive negotiation process) required, before the start of binding arbitration? Is arbitration suspended until completion of the project? Is the arbitrator allowed to award legal costs to the successful party? In a multi-party situation, are all necessary parties bound to the same dispute resolution process? (See also my prior post on the pros and cons of arbitration vs. litigation.)

Dispute resolution clauses are often taken “off the shelf.” Yes, there are other issues that are usually much more pressing when you are negotiating the terms of a construction contract.  In the end you may decide to live with whatever dispute resolution process the other party has proposed. But don’t sign without at least considering if the dispute resolution clause is flawed or unfair.

Significant SCC Decision Increases All Risk Insurance Coverage

Authors: Jennifer Biernaskie and Will Johnston

Today, the Supreme Court of Canada (the “SCC”) issued a decision dealing with coverage under a builders’ risk insurance policy that has important implications for owners, contractors and insurance companies. At issue was the interpretation of the exclusion of coverage for “the cost of making good faulty workmanship,” which appears in many commercial risks policies.

Following installation of windows at a highrise commercial tower, the window cleaning company hired by the owner to remove paint from the windows scratched and damaged the surfaces by using improper tools and methods. The owner submitted a claim for the costs to replace the damaged windows. The insurance company denied coverage relying on an exclusion in the policy precluding coverage for the “costs of making good faulty workmanship”. There was an exception to this exclusion that the owner relied upon. This exception provided that coverage would still be available for physical damage resulting from the faulty workmanship.

The SCC confirmed that the insured has the initial burden of proof, and must establish that the scope of coverage encompasses the damages. In this standard form builders’ risk policy, the coverage was very broad and included all physical loss and damages. At trial, the insurance company conceded that the damage fell within the broad coverage. Once this initial burden is met, the insurance company had to establish that any exclusions in the policy applied. Thus, the issue to be determined was whether the physical damage to the windows resulting from the improper cleaning methods was covered by the policy as an exception to the exclusion.

In this case, the SCC overturned the Alberta Court of Appeal, agreeing with the owner that only the costs of cleaning the re-installed windows would not be covered as a result of the exception. They concluded that it is not necessary for an exclusion to have a direct correspondence to physical loss. Instead the exclusion could be limited to the costs of the faulty workmanship alone. The result was that the exclusion clause only applied to the cost of redoing the faulty work (i.e. the cost of re-cleaning the windows). The physical damage to the windows themselves was not excluded due the exception for resulting damage. The SCC agreed that both of the proposed interpretations from the owner and the insurance company were plausible such that the contract was ambiguous. The court resolved the ambiguity based upon the overarching purpose of the insurance contract which is to provide broad coverage. The owners’ interpretation furthered the purpose of the contract. Conversely the insurance company’s interpretation undermined the purpose of the policy. The insurance company was required to pay for the replacement costs of the windows and could only refuse to pay for the cleaning costs afterwards under the faulty workmanship exclusion.

The fact that the window cleaning company was different from the window installation company appears to be significant. If only one company had installed and washed the windows under a single contract, it seems that the exclusion clause would have precluded coverage for the cost of replacing the windows and subsequent cleaning. If there had only been one contract, the SCC appears to suggest that the faulty workmanship would relate to the entire scope of work for both installation and washing such that the faulty workmanship exclusion would have precluded coverage for the replacement costs.

The result of this decision is very significant for parties to construction insurance contracts which are variably referred to as builders risk, contractor’s risk, all risks, multi-risk and course of construction insurance. Typically these policies are issued to owners and general contractors to cover all physical risks to the construction site.

In light of this decision, it may be prudent for owners and contractors to separate work that poses significant risks of damaging other expensive portions of the project into separate contracts with different trade contractors. This could facilitate increased coverage under a builders’ risk policy by establishing a basis for owners and contractors to argue that faulty workmanship is limited to the scope of each contract and therefore any detrimental effect of poor performance by one contractor upon other another contractor’s work fits within the exception of resulting damage (and therefore the loss is insured). Arguably this would establish coverage for losses that would otherwise be excluded on the basis of faulty workmanship if all the work is performed under one contract. Overall, this decision certainly benefits owners and contractors by confirming a broader interpretation of builders’ risk policies.

Insurance companies should be aware that the exception for resulting damage from the exclusion of coverage for faulty workmanship will not afford them the degree of protection they may have intended, or believed to be in place based on prior case law. In this case, an improperly performed $45,000 window cleaning contract resulted in approximately $2.5 million in liability for the costs to replace windows that were damaged as a result of faulty workmanship.

Lien Pitfall – Liening the Wrong Interest

Author: Corbin Devlin

A common pitfall for lien claimants is the risk of liening the wrong interest in land. The most common example of this error is the lien against the owner’s title (fee simple) in relation to work performed at the request of a tenant.

Liens Against Tenants
 
When work is done for a leasehold tenant, a lien may be claimed against the leasehold estate. This is because a builders’ lien relates to the interest of an “owner” as that term is defined in the Alberta Builders’ Lien Act (the "Act"). Confusingly, the definition of “owner” in the Act is not necessarily consistent with other legal concepts of ownership or common sense.

In section 1 of the Act, “owner” is defined as follows:

"owner" means a person having an estate or interest in land at whose request, express or implied, and

1. on whose credit,
2. on whose behalf,
3. with whose privity and consent, or
4. for whose direct benefit,

work is done on or material is furnished for an improvement to the land and includes all persons claiming under the owner whose rights are acquired after the commencement of the work or the furnishing of the material.

This wordy definition means that when a registered landowner hires a contractor, the contractor has the right to lien the title of the land. However, when a tenant hires a contractor, the contractor has the right to lien the tenant’s lease. (It is usually the case, when work is performed for a tenant, that the tenant meets the statutory definition of “owner,” while the actual registered legal landowner does not qualify as an “owner” as defined in the Act.)

Liens Against Landlords
 
Fortunately (for lien claimants) that is not the end of the story. There may be multiple “owners” for lien purposes – with the consequence that multiple interests in land can be liened.

A lien in relation to work done for a tenant may also be claimed against the estate of the holder of the fee simple title (i.e. the registered landowner, or landlord) in two circumstances:

1. if the lien claimant gives notice under section 15 of the Act; or
2. if the landlord also qualifies as an “owner” as defined in section 1(g) of the Act (i.e. if the work was done at the landlord’s request, etc.).

Section 15 Notice
 
When the lien claimant is working for a tenant, he may want the ability to lien the landlord’s interest for additional security. The Act allows the contractor or material supplier to serve a notice upon the landlord and, if the landlord does not respond, the landlord cannot later object when its interest is liened. (Per section 15(1) of the Act: …”if the person doing the work or furnishing the material gives to the person holding the fee simple, or that person’s agent, notice in writing of the work to be done or materials to be furnished, the lien also attaches to the estate in fee simple unless the person holding that estate, or that person’s agent, within 5 days after the receipt of the notice, gives notice that the person holding that estate will not be responsible for the doing of the work or the furnishing of the materials.”)

Landlord Requesting Work Done For A Tenant
 
Quite often, however, the question of liening the landlord’s interest will not arise until much later when problems develop. If no statutory notice has been provided, or if the landlord objects to the statutory notice, the only way a landlord’s interest is subject to lien claims (in respect of work contracted by a tenant) is if the landlord falls within the definition of owner provided in the Builders’ Lien Act. Yes, it is possible that both landlord and tenant meet the statutory definition.

The critical question is usually whether the landlord expressly or impliedly requested the work. If the landlord was sufficiently involved in the construction effort, the lien claimant may have a right to lien the landlord’s interest. The case law is clear however that mere knowledge of the work (on the part of the landlord) is not enough to give the contractor a right to lien the landlord’s interest. Lighting World Ltd. v. Help-U-Build (Edmonton) Inc. is an example where the landlord occasionally visited the construction site to observe the ongoing work, and loaned money to the tenant for the purpose of the construction, but did not provide any direction to the contractor, and did not provide any direction to the tenant as to how the construction should be done; she was held not to be an owner and the lien claim was dismissed. In another case, the lease agreement bound the tenant to have certain specific renovations carried out. The plans for the renovations had to be submitted to the landlord for approval. The court nevertheless concluded that the landlord did not expressly or implied request the work. Generally, the courts do not allow a lien against a landlord’s interest in respect of work done for a tenant unless the landlord actively participates in the work, typically by directing either the contractor or the tenant regarding the work.

Practical Points 

In sum, a contractor working for a tenant has the right to lien the tenant’s lease, but this may be inadequate security for payment. The contractor working for a tenant does not automatically have the right to lien the landlord’s interest; it depends on the use of a section 15 notice or unusual involvement by the landlord in the tenant’s construction project.  The contractor concerned about security for payment may not want to rely exclusively on his lien rights in any event, but this may be a particular concern where work is performed for a tenant such that lien rights are limited.

And getting back to the lead point of this article, the contractor working for a tenant must be sure to identify the correct legal interest when registering a lien; specifying the landlord’s interest in the Statement of Lien, when the contractor only has lien rights against the tenant’s interest, results in a lien that can be declared invalid.

Compromising on Consequential Damages

Author: Corbin Devlin

The potential loss to the owner if something goes wrong during construction (e.g. business interruption, loss of production…) is often far greater than the cost of construction. Owners reasonably want to hold contractors accountable for delays or other events in the contractor’s control that may affect the owner’s bottom line. But contractors reasonably don’t want to take on a risk that greatly exceeds the value associated with a particular contract. For a time it was common to see broad exclusions of consequential damages in industrial construction contracts. Sophisticated contractors in Alberta were simply unwilling to accept a risk of the magnitude likely to be associated with the delay or shutdown of a revenue-generating asset.

Now the trend appears to be towards a more complex sharing or allocation of risk.

• Limitations (monetary caps) on consequential damages, rather than a complete exclusion of liability for consequential damages (alternatively, a cap on all possible damages arising from the contract).
• More elaborate definitions of risks that are or are not excluded (e.g. instead of an exclusion clause that simply refers to consequential or indirect damages, a more detailed listing of excluded damages such as losses caused by business interruption, loss of profits, loss of downstream contracts…)
• More exceptions to the exclusion (Contractors: beware of the clause that excludes liability for consequential damages, excepting any consequential damages that are foreseeable; ask yourself, is it foreseeable that a construction mishap could take down the existing plant for a period of time? If the answer is yes, then this exclusion clause does not protect against liability for the very significant losses associated with such an event!)
• More prevalent use of liquidated damages in industrial construction contracts (in place of consequential damages for delay, some form of liquidated damages may be payable, ideally in an amount sufficient to hold the contractor accountable but not so great as to present a risk of bankrupting the contractor).

Contract provisions excluding consequential damages are not all the same. Now more than ever, these clauses can be very narrow or very broad in scope and effect, and should be the subject of deliberate review and negotiation.

General Contractor vs. Construction Manager - What's In A Name

Author: Corbin Devlin

Very often, the difference between a general contractor (GC) and a construction manager (CM) is not what we believe it to be. The specific terms and conditions of the contract - not the titles (General Contract vs. Construction Management Agreement) – are what define the rights and obligations of the parties. In particular, construction management can be a very malleable concept.

CM Agreements Can Vary Greatly
 
First, the term "Construction Manager" embodies more than one contract model. In a more traditional CM Agreement, the CM is advisor to the owner, and often acts as the owner's agent; but the owner contracts with trades and suppliers. In contrast, there is the CM-at-risk model; a CM-at-risk takes on responsibility for construction, and contracts with trades and suppliers directly. It is often unclear from the document title alone whether a particular CM Agreement is one or the other. But these different CM arrangements are substantially different, both legally and practically speaking. In my view, a CM-at-risk relationship has more in common with a GC relationship than it does with a more traditional CM relationship.

Second, one CM Agreement can differ quite significantly from another. Pricing and payment structures, allocation of responsibilities, the procurement process, involvement in pre-construction, and most importantly responsibility for the design, work and schedule; all these components that define the relationship tend to vary not only between GC and CM relationships, but also from one CM relationship to the next. The CM role is one that lends itself to customization.

Assumptions Lead to Failures and Disputes
 
As a result, I have seen a number of owners, contractors – and particularly construction managers - making the mistake of assuming that roles, responsibilities and lines of communication are the same from one construction management relationship to the next. Sometimes it is a failure to recognize the distinction between a construction manager-at-risk and other CM arrangements. More often, it is a case of assuming that a new CM contract is basically the same as the one before. The fact is, there is a great variety of custom CM and GC contracts in use, and even "standard" contracts such as CCDC 5A and CCDC 5B* may vary widely once special conditions are incorporated. Such mistakes can often lead to legal disputes, as different perceptions regarding the CM's role can lead to tensions, and assumptions regarding the CM's role can lead to failures of coordination, supervision, scheduling and communication.

Read the Contract
 
At its' core, I guess this post is simply a reminder to read the contract. And… don't pay too much attention to the title of the contract document. Whether it is entitled General Contract or Construction Management Agreement (or something else altogether) is sometimes more misleading than helpful, as it can lead to incorrect assumptions regarding the relationship structure and contract obligations.

*CCDC 5A is an example of a more traditional CM Agreement; CCDC 5B is an example of a CM-at-Risk Agreement.

Indemnity Clause "Red Flags"

Author: Corbin Devlin

In most construction contracts, there is nothing more tricky than the indemnity clause. Indemnities don’t come into play on most projects (but when they do, it is because something has gone badly wrong.) As a result, indemnity clauses often get short shrift in negotiations.

A blog is no place for a discussion of such a complex subject. Or is it? Determining whether or not an indemnity clause is problematic is the starting point.

With the intent of giving a complex subject a simple treatment, this is my list of “red flag” issues that call for (re)negotiation of an indemnity clause:

• Indemnity for risks out of your control: This is a basic principle. The indemnitor (the party with the burden of the indemnity clause) should ask, am I taking on any risk under this indemnity clause that I cannot control? The purpose of indemnities is (or should be) to attach a particular risk to the party best able to control that risk.
• Indemnity for risks controlled by the other party: This is worse. Unless you are in the insurance business, you should not agree to indemnify the other contracting party for something in their control.
• Indemnity for losses resulting from the other party’s own negligence: This is the absolute worst. (Fortunately, this is also a very rare animal. And the Canadian courts say that they won’t imply an obligation to indemnify the other party for a loss caused by their negligence unless the contract says so in the most clear and obvious language. I have seen such express clauses, but not many.)
• Indemnity for an uninsured (or uninsurable) risk: This is another basic principle. The indemnitor should always be asking, do I have insurance that protects me against these risks covered by the indemnity clause?
• Indemnity without limit: Is there no cap on the indemnity obligation? Remember that insurance policies have monetary caps; an indemnity without a cap is a sure sign that the indemnitor are taking on an uninsured risk (i.e. in excess of policy limits).
• Indemnity disproportionate to the contract: Is the indemintor taking on risk under the indemnity clause that is far greater than the contract value? Would the indemnity clause put the company at risk of bankruptcy if the unexpected comes to pass?
• Indemnity for consequential damages or economic loss: Indemnity clauses broad enough to include consequential damages or economic loss require very careful consideration. By definition, such indemnity clauses expose the indemnitor to liability that is broader than ordinary principles of contract law or common law would allow. (Perhaps another day I will elaborate; this is a topic that warrants an article of its’ own.)
• Indemnity for negligence or breach of contract: Now we are getting into clauses that are common, but require caution. Indemnity clauses that cover negligence or breach of contract expose the indemnitor to potential liability for unforeseeable losses. But at least such obligations require the indemnitee to prove that the indemnitor was negligent, or breached the contract. If the indemnitor has to give such an indemnity, the other “red flags” mentioned in this list become even more important; e.g. If you must agree to indemnify the other party for any loss resulting from your breach of contract, can you negotiate a monetary cap, and/or an exclusion of consequential damages or economic loss?
• Indemnity for any loss “arising from or related to” the work: Such broad indemnity obligations do not depend on proof of negligence, or breach of contract – it may be sufficient to trigger indemnity obligations if the loss is (somehow) related to the work, even without negligence or breach of contract. Therefore, such indemnities require even more caution than indemnities for negligence or breach of contract. Once again, however, such indemnity clauses may be fine – if they are otherwise subject to some reasonable limitations in scope and amount.

There are infinite permutations of project risks, indemnity provisions, and insurance programs; an indemnity clause may be unreasonable in once case but justifiable, even necessary, in another case. Be sure to consider the indemnity clause in the context of possible real world risks on the project (bodily injury, damage to existing facilities, delay in completion, environmental risk…) and the project insurance program. Just don’t ignore the indemnity clause or treat it as boilerplate. A bad indemnity clause can be a very big problem, not only when that unexpected loss occurs but also in the event of any contract dispute.