American Bar Association Forum on Construction Law Warranties, Guarantees and SOLS, Oh My! Suzanne M. McSorley Stevens & Lee, P.C. Lawrenceville, NJ Christopher E. Ng Gibbs Giden Locher Turner Senet & Wittbrodt LLP Los Angeles, CA Presented at the 2015 Annual Meeting April 15-18, 2015 Boca Raton Resort & Spa, Boca Raton, FL 2015 American Bar Association
Construction lawyers work daily with warranties and guarantees, both in negotiating and drafting appropriate warranties (and, at times, guarantees) and in working to resolve disputes arising out of those promises. For the most part, warranties and guarantees, and the statutes of limitation applicable when disputes arise under them, are creatures of state law, with surprisingly wide variation from state to state. We have set out here first to distinguish warranties from true guarantees, and then to discuss the warranties most commonly provided or imposed in connection with construction projects. Finally, we have laid out a primer for analyzing the application of statutes of limitation when disputes arise under warranties. We have tried here to give a good primer, with references to statutes and case law from a variety of states throughout the county, but there is no substitute for researching the case law governing the question in your jurisdiction. I. Distinguishing Warranties from Guarantees It is not uncommon for actors in the construction industry to use the terms warranty and guarantee interchangeably. This is understandable, given that phrases like the contractor or manufacturer guarantees are often used in the language of warranties. But the terms, in fact, refer to very different obligations and it behooves the construction lawyer to use the terms appropriately, when analyzing a claim or when drafting contract language. A warranty is an assurance by one party to an agreement of the existence of a fact upon which the other party may rely; it is intended precisely to relieve the promisee of any duty to ascertain the facts for himself. Thus, a warranty amounts to a promise to indemnify the promisee for any loss if the fact warranted proves untrue. 1 Stated differently, it is [a] statement or representation made by the seller... as a part of the contract of sale,... having reference to the character, quality or title of the [subject matter of the contract], and by which he promises or undertakes to insure that certain facts are or shall be as he then represents them. 2-1-
In a construction project, a warranty therefore is an assurance given by one party (generally, the prime contractor, its subcontractors and material suppliers) to another party (most commonly the owner or other upstream contracting party) that the warrantor will complete its work in a particular way and that it will achieve a particular outcome. 3 Typically, construction contracts include at a minimum a contractor s promise to perform the work in a good and workmanlike manner and in accordance with the contract documents, and the promise of an equipment or material supplier that it guarantees its products will be free from manufacturing defects for some period of time. 4 In the next section of this paper, we identify, describe and discuss the wide variety of warranties commonly extended by one party to another in the typical construction project, as well as the warranties imposed by statute, and those implied by law. 5 On the other hand, a guarantee is a promise on the part of one person, the guarantor, to pay a debt owed by another in the event that the primary obligor fails to perform in accordance with his promises. As such, a guarantee creates a secondary liability which is collateral to the principal s contractual obligation. 6 Since a guarantor s payment obligation is secondary to that of the principal obligor, it is the principal s failure to perform under its contract that triggers the guarantor s obligation under a guarantee. 7 The prototypical guarantee is the guarantee of payment provided by one person (e.g., a shareholder of a corporation) to a lender in connection with another person s (the corporation s) borrowing. In the construction context, one can also often find a parent company or other third party guaranteeing a party s (the owner s or a contractor s) payment or performance obligations under the construction contract. True guarantees are much like sureties and, in fact, some states, including, for example, California, have abolished the distinction between them. 8 Other states, however, including New York, continue to consider a guarantor s obligations to be distinct from or different than the obligations of a -2-
surety. 9 In all instances, however, a guarantor s obligations are generally considered to be separate and apart from the primary obligations of the principal created in the note or contract itself, and are limited to the scope (and conditions) set forth in the guarantee instrument. 10 A guarantor does not have a primary obligation to re-pay the loan (or to pay the subcontractors or to complete the project). Its obligation to do so arises only if, and then after, the primary obligor has failed to perform those obligations. In summary, warranties are promises given by one party to a contract to another party to that contract regarding facts, conditions or performance which protect the parties expectation interest in the contract. Guarantees, on the other hand, create a secondary obligation on the part of the guarantor to step in for the primary obligor in the event if his default. Because a guaranty creates a secondary obligation, guarantees require three parties: the obligor (e.g., the contractor or the borrower), the obligee (e.g., lender or the project owner), and the guarantor, while a warranty requires only the two parties to the warranted agreement. This paper deals exclusively with warranties. II. Construction Warranties Construction contracts contain a wide variety of warranties. For construction practitioners, warranty issues are pervasive in both the contract drafting and claim resolution processes. A. Warranties in General 1. The Intersection of the Uniform Commercial Code and Common Law the Predominant Factor Test Generally speaking, a state s common law governs most construction warranties. The state s version of the Uniform Commercial Code (UCC), however, which governs the sale of goods, is the source of warranty obligations in connection with the sale of construction equipment, materials and other goods. 11 Practitioners often overlook the complexity in determining whether the common law or UCC applies to a warranty, mistakenly assuming that the UCC does not apply to warranties provided in -3-
connection with a contract that requires the provision of services. In fact, when a contract, like most construction contracts, anticipates that a party will provide both goods and services, most jurisdictions will apply the UCC to that contract if the predominant purpose of the parties contract is the sale of goods. Thus, most courts will apply the UCC to disputes such as those over the improper installation of equipment or materials when the predominant purpose of the underlying contract was the sale of the material or equipment, and not their installation. 12 2. Express Warranties: Creatures of the Parties Contract Express warranties may be created orally or in writing. 13 Although an express warranty does not require formal words of creation, an express warranty does not exist absent specific language in the contract at issue. 14 The best drafted warranties include terms such as warrant, guarantee, or assure, all of which are used in construction industry form documents. In general, all that is required under the common law is any affirmation or promise, although under the UCC, only an affirmation or promise which becomes the basis for the bargain between the parties creates a warranty. 15 The contract language can, for example, promise a performance result or conformance to a specific model or sample. 16 For example, an express warranty may provide that a newly-installed roof will not leak for 15 years or that a retrofitted commercial building can withstand collapse from a magnitude 8.0 earthquake. Sales brochures, product data, and samples can be ripe with express warranties. 17 Failure to perform or achieve the promised objectives constitutes a breach of an express warranty. Amongst all conceivable express warranties, the most frequently encountered and litigated warranties are the express warranties relating to the quality of the work and the contractor s call-back obligation to remedy defects. These are discussed in more detail below. 3. Implied Warranties: Creatures of State Law Unlike express warranties, implied warranties are judicial doctrines that impose extracontractual obligations on parties as a matter of law. As with express warranties, implied warranties are -4-
governed by state common law for service contracts and by the UCC for sales of goods contracts, with the predominant factor test playing an important role in determining which law applies for hybrid contracts. In general, courts construe express and implied warranties as both cumulative and consistent where possible. 18 Implied warranties are especially essential when there are either no pertinent express warranties for workmanship or when an express warranty does not otherwise apply, perhaps because of a failure to give required notice. In such cases, many states imply a warranty that the work and materials will be good and workmanlike and free from any significant defects. Most states also imply a warranty of habitability in connection with residential projects (separate and apart from any express or statutory warranties). These warranties are either related to conduct, like the implied warranty of workmanlike performance (or end-result ) meaning the goods are both merchantable and fit for their intended purpose or not, 19 leading some jurisdictions to enforce such warranties under a strict liability standard while others utilize a negligence standard. 20 Some states have adopted statutory warranties (which, by their very nature, are implied unless expressed or otherwise specifically incorporated into the contract) for certain types of construction contracts. At times, these statutory implied warranties supersede the parties express warranties or the standard common law warranties. In Minnesota, for example, the seller of a newly constructed residential building warrants that the building will be without defects from poor workmanship for one year. 21 The seller must also warrant the plumbing, electrical, and HVAC for two years and any load-bearing structures for ten years. 22 Minnesota law forbids waiver or modification of these warranties. 23 Similarly, New York requires developers or contractors to provide the same warranties for years one and two, but adds a six-year warranty against any material defects. 24-5-
Florida imposes an implied warranty of fitness from contractors, subcontractors, and suppliers to each purchaser of a condominium unit. 25 Specifically, the statute provides that these construction entities warrant the roof, structural elements, and common plumbing and mechanical systems for three years, as well as a one year warranty for all other components. 26 Other examples of such warranties include Louisiana s warranties for new residential construction 27 and New Jersey s New Home Warranty Program 28. Thirty-eight states, including California, have specific warranties for manufactured homes. 29 It goes without saying that practitioners should familiarize themselves with pertinent state statutes that imply warranties into construction contracts. 4. Overlaps and Gaps in Warranties As noted above, contracts for the sale of goods are subject to the UCC while contracts predominantly for labor and services are governed by common law. 30 A supplier of goods is bound not only to the express warranties contained in its contract, but also to all of the warranties provided under the UCC, unless such warranties are properly disclaimed. These warranties may expire sooner than warranties would under common law. In addition, those same goods, when warranted by a subcontractor to a contractor or a contractor to an owner, may be governed by common law instead when they are part of a larger services contract. Sometimes, subcontractors agree to broad warranties regarding scope, remedies, and time that will not be honored by the suppliers. In many cases (e.g., when there is only an alleged economic loss), the owner will not have a remedy against the supplier, but only from the subcontractor. Other times, original contractors and subcontractors can limit their exposure to certain warranty claims by agreeing that the contractor is only responsible for its own labor and materials, while at the same time assigning all warranties from subcontractors and suppliers upstream. Or, a party can limit (by contract) the damages available for any breach of express warranty to the repair or replacement value of the -6-
allegedly defective goods. Ultimately, all parties up the chain must be cognizant of the overlaps and gaps between warranties supplied by their lower-tiers. 31 B. Owner s Warranties 1. The Spearin Doctrine and the Owner s Design Specifications Not all warranties run in favor of the owner or upstream contractor. In fact, many jurisdictions impose on the owner an implied warranty regarding the information it provides to its contractor, in particular, that the plans and design specifications furnished to the contractor are sufficient for the construction of the project, making the owner responsible to the contractor for the consequences of design defects in those plans and specifications. 32 Design specifications describe in detail the materials to be employed and the manner in which the work is to be performed, leaving the no discretion to deviate from them. 33 Consequently, in 1918, the United States Supreme Court in United States v. Spearin determined that [d]etailed design specifications contain an implied warranty that if they are followed, an acceptable result will be produced. 34 Spearin and its state law analogues only apply to design specifications. If the contract documents put design responsibility on the contractors and their subcontractors, as with performance specifications, Spearin will not apply. 35 The Spearin doctrine often protects a contractor in a situation in which the contractor cannot make a differing site condition claim. 36 A contractor can argue that the owner impliedly warrants that the work can be performed in accordance with the contract documents and within the owner-mandated schedule. 37 However, if the contractor suggests changes to an owner s plans and specifications, the contractor will have warranted as to the adequacy of the proposal and that the substitution will yield adequate results. 38-7-
Spearin is most potent where an owner requires the use of a specific product for the project. In that situation, a contractor will not be liable if the product proves insufficient for the intended use. 39 Similarly, when requiring a single-source product, the owner also impliedly warrants that the particular product is commercially available. 40 These situations are not the same as when a product is unsuitable because of a manufacturing defect. 41 However, Spearin and similar implied warranties will not apply where the owner suggests, but does not require, the use of a particular product. 42 Generally, contractors successfully argue the Spearin doctrine in defense to breach of express or implied warranty claims by the project owner when they can prove that they complied with the owners plans and specifications. 43 In such cases, contractors argue that the owner s implied warranty of the plans and specifications supersedes the contractor s workmanship and material warranties. 44 Depending on the facts and circumstances, however, some courts may determine that the contractors express warranties may trump the owner s implied warranty. 45 Importantly, an owner cannot argue that the warranty is superseded by the contractor s contractual obligations to examine the project site, review the plans, and assume responsibility for the work until completion and acceptance. 46 Contractors may also rely upon the Spearin doctrine to assert an affirmative claim against a project owner for delay, disruption or other impact damages. 47 However, the contractor s right to recovery for the owner s breach of its implied warranty of the adequacy of design [is] conditioned upon the contractor s reasonable reliance upon the owner s defective design in preparing its bid and in doing the work. 48 This is not an absolute defense; if the contractor knew or should have known about defects in the plans and specifications and did not warn the owner, he may be liable. 49 An owner may disclaim its implied warranty of the plans and specifications. However, because of the public policy concerns with allowing an owner to avoid warranting its design and imposing design obligations on contractors without design expertise, these disclaimers are strictly construed. 50 Disclaimers cannot be boilerplate, must be specific, and account for whether or not the contractor was -8-
paid to warrant the project s design. 51 Therefore, if the contractor s obligations are sufficiently specific, they may relieve the owner of its obligations. 52 In addition, if the contractor affirmatively warrants as to the adequacy of the owner s plans and specifications, the contractor may have relieved the owner of its warranty. 53 2. Implied Warranty of Full Disclosure Some states augment the Spearin doctrine with a court-imposed duty on the part of the owner to disclose to the contractor material information that is relevant to the project. 54 Typically, the obligation relates to information that would impact the contractor s performance, such as unusual or adverse soil conditions or information learned through prior projects. 55 However, if the contractors could discover this information through a reasonable investigation, the owner is ordinarily not required to disclose it. 56 In general, an owner cannot disclaim an implied warranty of full disclosure through general exculpatory contract provision. 57 However, if a contractor unreasonably relies on information the owner provided, the owner may not be liable for breach of this implied warranty. 58 C. Contractor s Warranties 1. Express Warranties Regarding the Work, e.g., AIA A201-2007 3.5 All popular construction industry form documents include express warranties with respect to goods and services. There is not any particular language that is required to create an express warranty, but it is necessary to set out the terms of the warranty and not just state that something is warranted. 59 The same express warranties contained in the typical form documents can also be created orally, within the limits of the statute of frauds. Moreover, it is equally possible to create express warranties by simply incorporating a standard form contract into a project s manual. 60 Because the quality of work warranties are especially important to project owners, such warranties generally establish the benchmark for the quality of the finished construction. Most standard form contracts do not merely -9-
require that the contractor complete work on time --- rather, the contractor must perform work in a good and workmanlike manner and furnish materials and equipment of at least a minimum quality. These warranty obligations encourage prime contractors to carefully monitor its own work and the work of its subcontractors to comply with its contractual warranty obligations. The standard express quality warranty under the AIA A201-2007 has three components. Specifically, Section 3.5 of the AIA A201-2007 provides: 3.5 The Contractor warrants to the Owner and Architect that materials and equipment furnished under the Contract will be of good quality and new unless the Contract Documents require or permit otherwise. The Contractor further warrants that the Work will conform to the requirements of the Contract Documents and will be free from defects, except for those inherent in the quality of the work the Contract Documents require or permit. Work, materials or equipment not conforming to these requirements may be considered defective. The Contractor s warranty excludes remedy for damage or defect used by abuse, alterations to the Work not executed by the Contractor, improper or insufficient maintenance, improper operation, or normal wear and tear and normal usage. If required by the Architect, the Contractor shall furnish satisfactory evidence as to the kind and quality of materials and equipment. Thus, AIA A201-2007 requires that: (1) the equipment and materials will be new and of good quality (unless otherwise specified); (2) the work will be free from non-inherent or permissible defects; and (3) the work will conform to the contract documents. a. Warranting the Quality of Materials Unless allowed (e.g., a building renovation), the contractor warrants that the materials and equipment will be of good quality and new. As an owner, it is important that the contractor also warrant any materials that the owner allowed to be substituted for those delineated in the contract documents; this way, the contractor s warranty obligations to the owner are not abrogated. 61 Courts, however, have held that a contractor creates an express warranty if it holds its product out as being equal to or better than the product called for in the plans and specifications. 62-10-
b. Warranting the Work s Conformance to Contract Documents The second component of Section 3.5 is the contractor s warranty that the work will conform to project plans, specifications and other contract documents. Here, the two crucial issues are (1) the degree of conformance; and (2) at what point does conformance equate to economic waste. Most contracts require strict performance to the contract documents, which courts have found creates an express warranty obligating the contractor to strictly adhere to the plans and specifications with the degree of workmanship normally possessed by those in the industry. 63 However, while the owner may have a right to strict compliance with the contract documents, the owner may not be permitted to enforce this obligation if the costs to repair or replace the defective work is economically wasteful and the work is otherwise adequate for its intended purpose. 64 Instead, the owner could be entitled to a downward adjustment in the contract price. Some projects contain express warranties outside of the general conditions. 65 For example, there are often other assurances set forth in contract documents, in particular the specifications that are enforceable as express warranties. Any such warranties and assurances with respect to goods are governed by the UCC. 66 A performance specification requires a particular result or dictates the intended capabilities or result of the work. In essence, the contractor promises that the work (or a portion of the work) will perform as specified. 67 For example, performance specifications for a rollercoaster at an amusement park may provide that the coaster reach a speed of 60MPH or performance specifications for a wastewater treatment plant could require that the plant be capable of processing 40,000,000 gallons of water per day. However, contractors must be weary of warranting or guaranteeing the satisfactory operation of all materials and equipment installed under [a] contract. 68 The Supreme Court of Washington held a contractor responsible for the satisfactory operation of the materials and equipment, despite potential design defects. 69 The court interpreted that statement broadly, stating -11-
that the contractor had assumed the risk to ensure the satisfactory operation regardless of defects in materials, equipment, or the plans and specifications. 70 In addition, the specifications may require that a building meet building codes. For example, a specification could require that curtain walls of a high-rise meet earthquake safeguards. In New York, building codes were updated after Hurricane Sandy to require mechanical systems be located above flood levels and one- and two-family dwellings to be two feet above current base flood elevations. 71 Thus, contractors should take care not to generally warrant that the work will be performed according to all laws, building code and regulations. By agreeing to such language, the contractor has arguably agreed to confirm that its work and the design is code compliant whereas the contractor should make sure that the design professional is responsible for code compliance of the design. c. Warranting the Work is Free from Defects The third component of Section 3.5 is the contractor s warranty that the work will be free from defects (except if permitted by the contract documents). In some popular industry form contracts, including ConsensusDOCS 200, the contractor is only required to produce a project that is free from defective workmanship and materials; but it does not require that the work be free from defects like AIA A201-2007. 72 As previously discussed, it is possible for a contractor to employ sufficient workmanship and materials, but still produce a project with defects. This warranty is most often the basis for breach of contract/warranty actions when defective work appears after the call-back warranty expires. 2. Limitation of Express Warranties One way to limit the effect of express warranties is to carve out exceptions to their applicability and/or limit the available remedies for any breach. When there is a clearly articulated limitation, courts may enforce it. 73 Courts will then consider whether such a limitation is unreasonable and beyond the contemplation of the parties at the time of contracting. However, the party attempting to limit its liability is not required to advise the other party of the risks associated with such a limitation. 74-12-
Language excluding all warranties, express or implied may be considered inconsistent with the express warranties provided elsewhere in a contract in order to protect the other contracting party from surprise. 75 Courts are less likely to monkey with a limitation negotiated by two commercial parties unless it is unconscionable or fails of its essential purpose. 76 One of the key limitations to the remedy for a breach of express warranty is the exclusion of consequential damages. 77 Often times, a contractor or supplier will couple the waiver of consequential damages provision with an express limitation of other damages to a specific dollar figure or the value of the contract amount. 78 However, in many (though not all) jurisdictions, it is contrary to public policy for an entity to limit its liability if that party has been solely negligent. 79 A201 also specifically excludes warranties when there is abuse, misuse, or normal wear and tear. Excluding warranties for improper operation is easier for the contractor to prove rather than abuse or misuse. For example, a contractor was sued for $300,000 in alleged design deficiencies for mobile compressors. 80 Because the government had not disclosed the specific intended use of the compressors, the contractor prevailed by arguing that the product was being used outside of its intended conditions as set out in the project s specifications. 81 3. Call-Back Warranty, e.g., AIA A201-2007 12.2.2.1 The call-back warranty is more like an owner remedy than a warranty, since it requires the contractor to return to the project to repair defective work during a particular time frame. As set forth in the AIA A201-2007, it provides: 12.2.2.1 In addition to the Contractor s obligations under Section 3.5, if, within one year after the date of Substantial Completion of the Work or designated portion thereof or after the date for commencement of warranties established under Section 9.9.1, or by terms of an applicable special warranty required by the Contract Documents, any of the Work is found to not be in accordance with the requirements of the Contract Documents, the Contractor shall correct it promptly after receipt of written notice from the Owner to do so unless the Owner has previously given the Contractor a written acceptance of such condition. The Owner shall give such notice promptly after discovery of the condition. -13-
During the one-year period for correction of Work, if the Owner fails to notify the Contractor and give the Contractor an opportunity to make the correction, the Owner waives the rights to require correction by the Contractor and to make a claim for breach of warranty. If the Contractor fails to correct nonconforming Work within a reasonable time during that period after receipt of notice from the Owner or Architect, the Owner may correct it in accordance with Section 2.4. Section 12.2.2.1, and similar contractual provisions, generally apply to nonconforming work discovered within one year of the date of substantial completion. A201 provides the industry standard one year call-back period. During this period, the contractor is required to correct nonconforming work upon written notice from owner that certain work does not conform to the contract documents. Moreover, if the contractor fails or refuses to correct work within a reasonable time, the owner may correct nonconforming work and backcharge the contractor for such costs. Unlike the fairly uniform quality warranties contained in industry form documents (including AIA, EJCDC and ConsensusDOCS), there are some material differences in the standard call-back warranty provisions of these form contracts. AIA A201-2007 and ConsensusDOCS 200 at section 3.9, both require the owner to provide proper notice to the contractor and an opportunity to cure known defects, 82 and if the owner fails to provide proper notice and an opportunity to cure, the owner may lose the right to insist on correction of the work or to claim breach of warranty. Both ConsensusDOCS 200 and AIA A201-2007 provide that the one-year call-back period does not constitute a limitations period for purposes of enforcing the quality warranty. 83 However, the two have expressly different approaches to whether the corrective work triggers a new one-year period; ConsensusDOCS 200 states that the performance of corrective work will not trigger a new one-year correction period for the corrective work, but AIA A201-2007 states the opposite. 84 From the owner s perspective, the contract should make it clear (as most popular industry forms do) that the call-back warranty is not in lieu of or a limitation to the contractor s quality warranty. Moreover, the call-back warranty provision should contain non-waiver language so that an owner s -14-
failure to invoke the call-back remedy does not waive the owner s right to assert a quality warranty or other remedies. (Undoubtedly, an owner or bond holder of a $300 million hospital or $250 million highrise office tower does not want to learn that it has only bargained for one year s use of the project!) In addition, the owner should provide separate written notices to cover all the non-conforming work, even if contractor fails to complete corrective work under one notice (or risk waiver of recovery right). From the contractor s perspective, such non-waiver language may be troubling. The contractor will want an opportunity to address any quality issues. The contractor, therefore, will argue that any non-waiver language defeats the call-back mechanism, which provides for notice of any perceived quality issue and allows the contractor the opportunity to cure. The contractor must also be certain that the contract delineates how the owner should provide the contractor notice to cure and the amount of time the contractor has to commence such work. Because the owner will likely be anxious to complete the repair work, a reasonable time to the owner is not likely a reasonable time to the contractor. The owner s call-back warranty is generally, but not always, triggered upon substantial completion of the project. In addition to the non-waiver language referenced above, most negotiations over the call-back warranty center around: (1) when the call-back warranty is triggered; (2) the length of the call-back warranty; (3) the duration of the call-back warranty period for any corrective work; (4) the time within which the owner must notify the contractor upon discovery of any defect; (5) the time within which the contractor has from notice of the defect to commencement of cure of the defective work; and (6) the legal damages and costs the owner may recover in the event of failure or refusal of the contractor to honor its call-back obligations. While it may appear that the owner would be entitled to specific performance by the contractor, the courts do not typically enforce such a remedy. 85 Moreover, a contractor may not be excused from performing callback work for an owner s failure to pay. 86 If the contract permits nonpayment or if the nonpayment did not substantially deprived the contractor of a benefit of the contract, then the nonpayment does not constitute a material breach -15-
and will not excuse the contractor s performance of callback work. 87 However, if the nonpayment is not permitted or it did deprive the contractor of a substantial benefit of the contract, there may have been a material breach which would excuse the contractor s performance. 88 When possible (sometimes the repair or replacement will become extremely costly and impossible for the contractor to perform when it has not been paid), the contractor should perform the callback work and pursue other remedies. Ideally, the owner s invocation of the call-back warranty will help the owner and contractor avoid arguments regarding whether certain repair and corrective work was necessary in the first place, in addition to whether the quality issues were properly and most efficiently remedied. Thus, the callback warranty helps to reduce or eliminate formal claims against the contractor and gives the owner a defect-free building with the contractor itself remedying any and all quality issues during the call-back period. 4. Implied Warranties a. Contractor s Obligation to Seek Clarification of Obvious Design Discrepancies Prior to submitting a bid, a contractor has an implied duty to seek clarification for any obvious discrepancies, conflicts, or omissions that the contractor did or reasonably should have discovered in the owner s design or contract documents. 89 Some Instructions to Bidders create an express duty by explicitly requiring contractors to inspect the site, plans and specifications, and bring any discrepancies to the attention of the owner. 90 Some courts have held that the implied warranty of workmanlike performance also obligates a contractor to notify the owner of potential defects in a project s design. 91 If the contractor fails to seek such clarification, the contractor is forbidden from seeking addition compensation for any discrepancy later corrected. 92 Unfortunately, there are unscrupulous contractors who bid the holes in a project, intending to seek lucrative change orders from the owner. However, because the contractor has the last clear chance to avoid disputes and change orders, it is obligated to mitigate the potential losses and disputes. However, this does not negate the owner s duty to warrant -16-
the plans and specifications. In Spearin, the seminal case about the owner s warranty of the plans and specifications, the court opined that the contractor s duty to examine the site, to check up the plans, and to assume responsibility for the work until completion and acceptance did not include a duty to determine if the project was constructible for its intended purpose. 93 To determine whether the issue was obvious, a court will consider: (1) the time available to bid the project; (2) the size of the project and documents; (3) the contractor s expertise, experience, and special knowledge in the field where the discrepancy is found; (4) the economic significance of the discrepancy; (5) how the project was bid and negotiated (i.e. last-minute or extended negotiations); and (6) the owner or designer s knowledge of the discrepancy and simplicity of clarification. If the owner can prove the discrepancy was obvious and the contractor should have known, not that the contractor actually did know, then the contractor may be liable. 94 When in doubt, contractors should seek clarification. b. Workmanlike Performance The implied warranty of workmanlike construction is recognized by many states. This warranty provides that contractors impliedly warrant that the project will be completed in a workmanlike manner. 95 This implied warranty does not guarantee a perfect project; rather, to satisfy this warranty of workmanlike construction, the contractor is required to perform its work to the standards of a similarlysituated contractor of average skill and intelligence. 96 As mentioned above, this is a conduct or proper efforts standard that depends on local practices and the contract specifications. 97 In the State of California, this warranty (referred to as an implied warranty of fitness ) ensures that the contractor s work will be performed with care, skill, reasonable expedience, and faithfulness and, likewise, that construction materials will also be fit for the project. 98 In Colorado, this implied warranty does not apply to public works projects. 99 Although a contractor can faithfully perform its work, the project may still contain defects. Similarly, the contractor can perform its work in an unworkmanlike fashion (e.g. not -17-
pay its subcontractors or finish late), and the project may not contain any defects. Therefore, this implied warranty is more related to negligence than strict liability. Traditionally, the implied warranty of workmanlike performance has been limited to initial purchasers. 100 However, subsequent purchasers, or others not in privity of contract with the contractor, often attempt to assert claims for breach of the implied warranty of workmanlike performance. 101 In most states, including Texas and Pennsylvania, courts hold that owners cannot assert claims for breach of an implied warranty of workmanship against suppliers or subcontractors with whom they have no privity of contract. 102 There are other states that differentiate between the potential liability of a contractor versus a subcontractor, holding that an owner can assert a breach of implied warranty of workmanship claim against the original contractor despite the lack of privity, but not against a subcontractor. 103 AIA A201-2007, and other form contracts, permit the owner to accept defective work. 104 Consequently, it is possible to waive the implied warranty. 105 However, final payment does not constitute a waiver, nor does inspecting the work or an express one-year call-back warranty. 106 While the implied warranty of workmanlike performance can be disclaimed, there is scant case law regarding successful disclaimers. Such a disclaimer must be sufficiently clear and unambiguous, which typically is not satisfied with a general disclaimer. 107 Moreover, in some states, an express warranty regarding a contractor s performance can eliminate the implied warranty of workmanlike performance if the express warranty sufficiently describes the manner, performance, or quality of construction. 108 That being said, it is unlikely that any commercial owner (or any savvy homeowner) would permit such a disclaimer. In states such as Florida, Illinois and Colorado, courts that have addressed the enforceability of such a warranty disclaimer in connection with residential projects have strictly construed such disclaimers against the party trying to enforce it. 109 After all, work performed in an unworkmanlike fashion is of little to no value to the owner. The contractor is in the best position to -18-
prevent losses and is the party with the experience, knowledge, and expertise in their particular field. There is strong public policy in favor of allowing an owner, or consumer, to reasonably rely on the contractor s expertise. c. Warranty of Habitability To combat traditionally one-sided terms imposed by homebuilders against purchasers of new homes, courts began to recognize an implied warranty of habitability. This judicially-created warranty obligates contractors to provide a home suitable for habitation and gives purchasers of new homes a remedy for latent defects discovered in their new homes. 110 What does suitable for habitation mean and what protection are homebuyers afforded by this warranty? In California, 1941.1 requires that a building possess: effective waterproofing and weather protection; proper plumbing facilities; hot and cold running water; sewage disposal; heating; codecompliant electrical lighting; facilities that are clean and sanitary; appropriate receptacles for garbage; floors, stairways, and railings in good repair; and a locking mail receptacle for each residential unit in order to be considered habitable. Many practitioners mistakenly believe the warranty of habitability is narrowly construed by courts and apply to defects affecting the safety or welfare of homeowners. In reality, however, many courts broadly apply this warranty to not just HVAC and roof defects, but attenuated improvements such as garages and even driveways. 111 Because the implied warranty of habitability is an end-result warranty, it is characterized as strict liability. There is a strong public policy in favor of providing homeowner s with the assurance that their home is habitable. 112 The contractor is in the best position to prevent the loss and bear the economic risk. 113 In order to combat a claim, the contractor s objective is to focus on whether the plaintiff s complaints truly relate to habitability. 114 The implied warranty of habitability is typically restricted to residential construction and rarely applied to commercial projects. 115 Moreover, recent common law demonstrates that the implied warranty of habitability may apply outside of the traditional new home homeowner-contractor or -19-
homeowner-developer context. In fact, the warranty has been applied to alleged defects in the construction of additions to an existing home, common area or elements of condominiums and other situations outside the norm. 116 However, some courts have limited the warranty to only latent defects in order to avoid actions for deterioration or loss of a bargain. 117 Moreover, many states do not allow an owner to state a claim for breach of the implied warranty of habitability, absent privity of contract. Other states, however, liberally interpret the warranty of habitability and permit claims against both original contractors and subcontractors despite the absence of privity. 118 Such courts reason that public policy dictates that the implied warranty of habitability must protect innocent homebuyers. 119 As with the implied warranty of workmanlike performance, courts disfavor disclaimers of the implied warranty of habitability since there is a strong public policy in favor of protecting generally unsophisticated homeowners. However, there is also something to be said for two parties freedom to contract. Such a disclaimer must be conspicuous and easily understood in order to be enforceable. 120 General disclaimers are not typically adequate, nor is as-is language. Even where they are permitted, there are strictly construed against the party attempting to use it as a defense to claims. 121 d. Warranty of Suitability of Construction Work A contractor s work is impliedly warranted to be reasonably suitable for such use as was contemplated by both parties. 122 Similar to the contractor s reliance on the Spearin doctrine, the owner must be able to rely on the contractor s work being in accordance with the plans and specifications. e. Implied Warranties for Materials and/or Equipment Incorporated Into the Project Warranties and assurances with regard to goods are governed by the UCC. These implied warranties benefit purchasers of the goods or downstream users. Likewise, warranty disclaimers are also governed by the UCC. 123 While the sale of equipment traditionally falls within the purview of the UCC, some states have also adopted the UCC provisions regarding equipment leases. -20-
(i). UCC 2-314 Warranty of Merchantability Section 2-314 of the UCC implies into contracts for the sale of goods, equipment, and materials that such goods are merchantable, meaning the goods are, among other things: (1) fit for the ordinary purposes for which such goods are used; (2) are adequately contained, packaged, and labeled as the contract requires; (3) possess even kind, quality, and quantity individually and collectively, as the contract requires; and (4) pass (without objection) in the trade under the contract description. Because this is an end-result warranty and not based upon conduct by the supplier or purchaser, a defendant may be liable even though he or she properly designed, manufactured, and sold his or her product. 124 This warranty has been held to apply to design-build contractors despite the fact that the contract was primarily for services rather than goods. 125 Construction defects and fabrication errors, however, do not generally result in a breach of the implied warranty of merchantability. Likewise, there is no breach of the implied warranty of merchantability if the goods provided are for a particular purpose and there is no ordinary purpose for which they are sold. 126 In order to prove a breach of the implied warranty of merchantability, the plaintiff must prove that: (1) the goods are unfit; (2) at the time of sale; and (3) the unfitness relates to the ordinary purpose of the goods. 127 Interestingly, states are relatively split with respect to whether they will allow a party not in direct contract with another party to enforce a claim for breach of the implied warranty of merchantability. 128 In California, for example, vertical privity (occupying adjoining links in the distribution chain) is generally required to maintain a claim for breach of implied warranty of merchantability. 129 Consumer exceptions to the privity requirement exist in some states, as well as when the enforcing party can prove it was an intended third-party beneficiary of the contract. 130 (ii). UCC 2-315 Warranty of Fitness for Particular Purpose The implied warranty of fitness for a particular purpose only applies when the seller (1) had reason to know of the particular purpose for which the goods were procured and (2) had reason to -21-
know that the buyer is relying on the seller s skill or judgment to select or furnish suitable goods. 131 The buyer must prove actual reliance on the seller s skill or judgment in selecting suitable goods. While most industries rely primarily on the warranty of merchantability, construction is different because the goods purchased are typically done so with respect to plans and specifications designed for a particular project. Consequently, suppliers of goods are typically aware of the particular purpose for which a product is being sought and the implied warranty applies unless an express warranty is given. When goods are designed in accordance with the buyer s specifications or substituted for a product called for in the plans and specifications, an implied warranty of fitness for a particular purpose may arise. 132 Simply providing a supplier with the plans and specifications for a particular project, however, is not sufficient to create the implied warranty of fitness for a particular purpose; instead, the supplier must be consulted as to its skill and judgment for selecting a particular good that will be suitable for the project. 133 Based upon that reasoning, some courts have held that design-builders are subject to the UCC and impliedly warrant that the project has been designed for a particular purpose. 134 (iii). Other UCC Implied Warranties In addition to the implied warranties set forth in 2-314 and 2-315, the UCC also implies into all contracts a warranty of good title, that is, that title to all materials sold will be good and that the transfer of any materials will be delivered free from any secured interest or other lien that is unknown to the buyer. 135 In addition, 2-314 of the UCC provides a broad implied warranty based upon the parties course of dealing or usage of trade. 136 f. Disclaimer of Implied Warranties Under the UCC Implied warranties can, and often are, expressly disclaimed in writing. There are various ways for implied warranties under the UCC to be disclaimed. As-is language or the buyer takes the goods subject to all faults may be sufficient to exclude all implied warranties. 137 This language should call the buyer s attention to the warranty disclaimer and make it clear that there is no implied warranty. In -22-
addition, the parties conduct, course of dealings and trade usages may waive or modify implied warranties. For example, if a buyer refuses to examine goods, the model, or sample, there are not any implied warranties if an examination would have revealed defects. 138 Similarly, if the buyer does examine the goods, the implied warranties for defects which should have been revealed during the examination are eliminated. 139 Under the UCC, suppliers and subcontractors furnishing goods and materials can disclaim the implied warranty of merchantability for such goods and materials with clear and conspicuous language that specifically refers to merchantability. 140 In fact, UCC 1-201(10) defines conspicuous as being written so that a reasonable person against whom it is to operate ought to have noticed it. Examples of such conspicuousness include language in the body of a form that is larger or other contrasting type or color or a printed heading in capitals (as: Non-Negotiable Bill of Lading). 141 The implied warranty of fitness for a particular purpose can likewise be disclaimed in a conspicuous writing. Such a disclaimer, however, does not have to specifically refer to that warranty and, rather, can use general language such as there are no warranties which extend beyond the description on the face hereof. 142 g. Limitations of Liability for Warranties Implied Under the UCC Coupled with warranty disclaimers, contractors often negotiate limitation of liability. As was briefly discussed above, there are gaps and overlaps in construction warranties. Typically, because of the superior bargaining power of suppliers over contractors, suppliers will often contract to limit their risk of loss to repair or replacement during a defined period. 143 However, the contractor still must provide warranties to the owner for the same goods. Therefore, the contractor is faced with the ultimate risk of substantial loss. 144 Fortunately, AIA A201-2007 4.3.10 provides some relief with its mutual waiver of consequential damage, stating: -23-