Rolling The Dice Without Putting It All On The Line: Protecting Contractors from Liability Exposure

Contractors face enormous liability exposure when bidding to perform construction work and related services in our highly industrialized and litigious society. Today, it seems we don’t even blink an eye when we hear of damage awards in the $10 to $25 million dollar range. Our society seems to have become desensitized to the catastrophic impact of damage awards which would severely impact, if not entirely wipe out, most contracting firms. Indeed, the revenue (and resulting profits) contractors expect to earn in today’s market bear no relationship to the risk of catastrophic loss to which they are exposed. In reality, a small mistake on a small job can result in a devastating loss.

When representing the contractor, the construction contract lawyer should counsel his or her client about exposures that may be beyond the client’s control and ability to manage. Hopefully, the contractor can afford insurance to cover severe liabilities. Jurors today tend to assume sophisticated contracting firms buy vast sums of insurance to cover such large liability exposures. But this is not always the case. Even for large contractors, coverage may be unavailable, or the policy limits may be insufficient to cover the loss. In addition, policy exclusions may negate coverage, leaving the contractor in an uninsured position.

In private work contracting, there is considerable opportunity to manage severe loss exposures through the bid and contract negotiation process.1 This is the first stage of the contracting process where severe risk may be qualified, ignored, or overlooked. The proactive contractor identifies severe risks to his customer at or prior to bid, and seeks to manage these risks during the bid and negotiation process. The prudent contractor will carefully weigh, and even walk away, from a job involving severe loss exposures that cannot be adequately managed through insurance, contractual protections, or both.

The risk of severe or catastrophic loss can arise in several areas: warranty obligations, broad form indemnity obligations, environmental hazards, professional errors and omissions, and consequential damages. Probably the single most significant way in which the contractor can protect himself against catastrophic loss is to negotiate a general limitation of liability. Samples of contract language are provided below for consideration in proposing alternatives to help manage these severe risks, from the contractor’s point of view.

THE SEVERE RISK OF WARRANTY LIABILITY

Contractors know they must stand behind their work for the contractual warranty period. Some may confidently believe their warranty obligation will involve only “spot repairs.” This may be wishful thinking. Depending on the project, the cost to remobilize, tear out, and repair or replace major portions of completed work can easily run into many millions of dollars. This is especially true if the

1 For public works projects, qualified proposals are considered non-responsive and subject to disqualification; but the risks must still be weighed. Contractors can pose questions to the public contracting authority, in advance of bid submission, about the level of risk to be imposed on the successful bidder. This may lead to an addendum to all bidders, altering the risk.

2 warranty work requires removal and/or replacement of substantial quantities of installed plant equipment and material. The contractor cannot realistically expect to be competitive by covering the risk of severe warranty losses through contingency pricing. Insurance will not pay losses due to faulty workmanship. Thus, careful consideration of the contractor’s warranty clause is critical.

The unsuspecting contractor may end up surprised to find the contract warranty clause is actually an obligation to warrant the workmanship of others. A completed project generally includes numerous material and equipment components, designed and/or installed by others. Where the contractor’s work must follow work by others, the contract may require the contractor to not only interface with that work, but also warrant the completed work in its entirety. The prudent contractor will qualify the warranty obligation to clearly apply just to the contractor’s own workmanship.

The commencement of the warranty period deserves close scrutiny. An owner’s or engineer’s unjustified and unilateral refusal to accept the contractor’s completed work can unfairly delay the start of the contractor’s warranty period until long after the owner has started using the work. Fairly drafted, a warranty clause provides for the warranty period to begin upon acceptance in fact, i.e. when the customer takes possession of, and begins receiving, the benefit of the contractor’s workmanship.

The object of a warranty clause should be to put the owner in the position to have non- conforming work corrected promptly. The contract should reserve to the contractor the right to repair non-conforming work, rather than undertake complete replacement, if a repair will produce the result

3 dictated by the contract plans and specifications.
The warranty clause should also require the owner to give the contractor fair notice of the non- conformity. Early investigation and prompt corrective action can mitigate the cost of performing warranty work. The clause should also provide for the owner to give the contractor access to the problem without having to bear extraordinary mobilization and tear-out costs.

Finally, a contractor’s limited warranty may be of little value to the contractor if the owner’s contractual warranty right is not made an exclusive remedy. The warranty clause should contain a clear and conspicuous disclaimer of all other warranties, whether statutory, express or implied, and provide that expiration of the warranty period bars further liability claims with respect to the work. Otherwise, the contractor may nevertheless remain vulnerable to extraneous claims, such as ordinary breach of contract and products liability claims, which can arise after expiration of the stated warranty period.