Problems in the major category

In a prior article, I discussed "punch list" issues. Normally, these are matters that concern minor touch up, repair and completion. So what happens when the problems are in the major category? In order to answer this question, let's assume that the defective installation is the electrical contractor's fault.

Final payment rule

If the owner is willing to accept the project, even with installation problems, that is all right and you may be off the hook. Final acceptance, followed by final payment, has major implications under federal government contracts. In particular, FAR 52.246-12(I) provides:

Acceptance shall be final and conclusive, except for latent defects, fraud, gross mistakes amounting to fraud, or the Government's rights under any warranty or guarantee. (Author's emphasis)

This statement is broad. It means that any obvious (patent) noncompliance with the drawings or specifications is waived by the government at final acceptance. Latent defects, on the other hand, are ones not reasonably discoverable on inspection. The government reserves the right to complain about those.

A looser description of the effects of final payment appears, for example, in AIA forms:

The making of final payment shall constitute a waiver of all claims by the Owner except those arising from: (1) unsettled liens, (2) faulty or defective work appearing after substantial completion, (3) failure of the Work to comply with the requirements of the Contract Documents, or (4) terms of any special guarantees... (Author's emphasis)

Exception (3) seems to kill the idea of "waiver," especially regarding defects, as it is so open-ended. However, there is case law that has adopted the latent/patent distinction. Those decisions hold that the owner cannot hold the contractor responsible for patent defects not brought to the contractor's attention before final acceptance. The waiver will apply, though, to other "claims" (delays, interferences with others, etc.).

Cost of noncompliance

Where there are defects or deficiencies in your work and they are not corrected, then the issue becomes calculating them with a dollar value. In many cases where the contractor does not make the corrections, it is because the owner has not paid, inducing the contractor to stop work, or because the owner has refused to let the contractor return. In other instances, the dispute concerns contract interpretation: Was the specification met or not?

The most common approach for the calculation is the "cost" of repair. This amount may be determined by a follow-on contractor's actual cost of repair, or by a consultant's estimate.

The goal of contract law is to put the owner in the position he would have been in but for the deficiency. In other words, the law places the owner where he would have been if the contractor had not breached the contract.

Keep in mind that the owner can make his claims even if he has not repaired or corrected the contractor's work. Indeed, there are instances where the owner is content to live with the defect without any fix being done, but the owner is still entitled to the "repair" costs.

In addition, the owner's entitlement is enforced even though the cost of repair far exceeds the value of the thing being fixed. There are, of course, some exceptions.

Value rule

Sometimes the cost of repair is absurdly high, yet the completed project is very usable. For example, a developer finds out too late that the houses just built are short some square footage. The owner is entitled to the benefit of his bargain with the contractor for the intended square footage, but it would be enormously expensive to reconstruct the houses to add the missing space.

In such an instance, the courts are apt to apply the "value rule." With this approach, the owner's expert evaluates the market value of the smaller houses in contrast to the value of the originally designed size. The owner then is entitled to recover from the contractor the amount of the reduction in value of the houses.

This approach is supported by the economic waste doctrine, since it would be economically wasteful to spend the excessive amount of money required to tear the houses apart when they are functionally sound as built. The major problem with the value rule is that the owner's recovery of damages may be severely diminished. In our example, the houses may not have decreased much in value from the loss of a few square feet, but the contractor may have saved a lot of money by shaving the footage.

Unjust enrichment

Which brings us to unjust enrichment. Why should the contractor in our houses' example be able to make money by shorting the developer?

Before I answer, consider this case from Florida. A new high-rise condominium was supposed to have all-copper piping. After completion, the owner learned that the contractor had secretly substituted PVC. The cost of tearing out and replacing the pipes would have been enormous, with little or no direct benefit to the condo owners since the PVC worked well and was installed properly.

The court rejected the cost rule (because of economic waste). But the value rule was also out since the judge found that the units' sales prices would not be affected by whether the pipes were copper or PVC.

The proper measure of damages was the savings to the contractor for his breach of contract. By having been paid his full contract value, he was unjustly enriched by the difference in price of the pipes.

Combining the rules

The nature of the defects in the work may support the application of a combination of these damages rules. For example, a homeowner may use the cost rule for fixing problems in the house caused by the contractor, such as light fixtures not installed or the installation of the wrong fixtures as per the specifications. However, the value rule might better apply to the installed swimming pool that is nine inches shallower than planned.

Conclusion

Putting a dollar value on deficiencies in the work is an essential task in assessing a problem situation. When you have not completed some of your work, or your work needs correction or repair, you should spend some time thinking about the "cost" versus "value" rules of damages. You'll do a better analysis of your problem and its consequences. EC

ITTIG, of Ittig & Ittig, P.C., in Washington D.C., specializes in construction law. He can be contacted at 202.387.5508, e-mail: [email protected], or his Web site, www.ittig-ittig.com.