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Difficult Coinsurance Problems In Builder's Risk Insurance

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Understanding the role (and risks) of coinsurance clauses in Builder's Risk insurance planning.

Understanding the role (and risks) of coinsurance clauses in Builder's Risk insurance planning.

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  • 1. ________________________________________Construction Law Newsletter Issue 41. Page 1Construction Law NewsletterPublished by the Section on Construction Law of the Oregon State BarISSUE No. 41 October, 2011UNDERSTANDING COINSURANCE PROBLEMSIN BUILDER’S RISK INSURANCESeth RowParsons Farnell & GreinLucy FleckWillamette Univ. School of LawDo you understand coinsurance? If so, youare one of the lucky few. Coinsurance is one ofthe least-understood concepts in all of insurancelaw. Attorneys involved with constructionprojects need to have at least a workingunderstanding of coinsurance, because missteps onthe front end with regard to coinsurance can haveserious consequences in the event of a claim. Forproperties under construction, coinsurancetypically comes into play in connection with“builder’s risk” insurance - insurance purchased tocover losses to property during construction.Including a coinsurance clause in abuilder’s risk policy will typically mean lowerrates. But in exchange for the lower rate, thepolicyholder takes on some risk of its own: If thelimit of insurance that the policyholder specifies isless than required, then the clause will act toreduce the amount the policyholder may recoverwhen it makes a claim, even if the claim is wellbelow limits. Therefore, it is important thatbuilder’s risk insurance policyholders take care toprevent or reduce the risk posed by thecoinsurance clause’s penalty.1. Builder’s Risk Insurance.The most common type of insurancecoverage on property while it is under constructionis builder’s risk insurance. Builder’s riskinsurance provides a specialized form of propertyloss coverage that specifically applies throughoutthe construction process. A broad builder’s riskpolicy insures against “all risks of direct physicalloss of or damage to” the property covered,including a contractor’s work and the materialsand supplies used in construction of the building.Typically, the terms of the construction contractwill dictate whether the contractor or the propertyowner is responsible for obtaining builder’s riskinsurance. Multiple parties are often covered bythe policy, including the owner, the contractor, anysubcontractors, sub-subcontractors, and financialinstitutions providing funds for the project(making the term “builder’s risk” something of amisnomer).There are several forms of builder’s riskinsurance, including (1) basic form, (2) completedvalue form, and (3) reporting form. The basicform provides a fixed amount of insurance and iscommonly paired with a coinsurance clause. Thisform is undesirable and rarely used. As the valueof buildings under construction increases, the limitof insurance must also increase; otherwise, thecoinsurance clause will activate to penalize theinsured. The completed value form, which is themost common type of builder’s risk policy,determines the limit of insurance by the expectedcompleted value of the project and also includes acoinsurance clause. However, the actual cost ofconstruction will often exceed the original projectestimate. Therefore, the completed value
  • 2. ________________________________________Construction Law Newsletter Issue 41. Page 2information should be updated if the project’sactual cost increases beyond the initial estimate.Under the reporting form, the limit of insurance isset high enough to cover the expected completevalue and the insured is required to report theactual value of the property periodically to theinsurance company. Coinsurance clauses are notcommon in “reporting” forms of builder’s riskinsurance.2. What Is Coinsurance?Coinsurance is found in most forms ofproperty insurance, of which builder’s risk is avariety. The coinsurance clause typically found inthe basic and completed value forms of builder’srisk insurance policies can be a significant sourceof confusion.Fundamentally, the coinsurance clause is apromise by the policyholder to purchase policylimits at a certain percentage of the property’svalue at the time of loss. If that promise is notmet, the insured will be penalized for under-insuring the property, which means that theinsured will have to absorb some of the loss itself.It is called “coinsurance” because if the penaltyapplies, the policyholder becomes a “coinsurer”with the insurance company, in that thepolicyholder will be responsible for paying part ofthe loss, along with the insurance company.To identify a coinsurance clause within abuilder’s risk policy, look for phrasing similar tothe following: “Need for Adequate Insurance. Wewill not pay a greater share of any loss than theproportion that the Limit of Insurance bears to thevalue on the date of completion of the buildingdescribed in the Declarations.” Coinsurance isusually set between 80% and 100%. As thecoinsurance percentage increases, the amount ofinsurance required also increases. An insurancecompany may explain a coinsurance policy in thefollowing way: “In exchange for lower rates, youagree to be insured for at least X% of theproperty’s value at the time of loss. If you are not,you become a coinsurer and share in any partialloss. There is a formula in the policy that tells youyour share: this calculation is commonly referredto as the ‘did over should’ formula.”Property-policy coinsurance is differentfrom, but often confused with, coinsurance in themedical insurance context. In medical insurancepolicies, coinsurance indicates the amounts of abill that the policyholder and the insurancecompany will pay. For example, if a medicalinsurance policy includes an 85/15 coinsuranceand the bill is $100, the insurance company pays$85 and the policyholder pays $15. Althoughcoinsurance terminology in the property insurancecontext is similar to the terminology used in themedical insurance context (for example, abuilder’s risk insurance policy may state “85%Coinsurance”), the way it applies to delineateresponsibility for damage or loss is quite different.3. The Coinsurance Penalty & HowInsurance Companies Calculate thePenalty.As noted above, coinsurance functions as apenalty if the property is under-insured. It applieswhen the limit of insurance purchased is less thana specified percentage of the insured’s propertyvalue at the time of the loss. When the amount ofinsurance the insured is carrying meets or exceedsthe specified percentage, the insured will recover100% of its claim and will not be penalized by acoinsurance clause. In that situation, thecoinsurance clause is not activated and does notreduce the insured’s amount of recovery.However, when the insured is carrying less thanthe specified percentage, the coinsurance clauseactivates and the insured is “penalized.”The penalty is best understood through anexample. Assume that a builder’s risk insurancepolicy contains a 90% coinsurance clause. Thatclause means that the insured is required to carryinsurance of at least 90% of the value of theproperty. If the property is valued at $500,000, theinsured must maintain a minimum of $450,000insurance on the property; otherwise, thecoinsurance clause takes effect and the insuredwill be penalized by not receiving full coverage ifthere is a loss.The amount of the penalty is determinedthrough a set of two calculations. The firstcalculates the percentage of the claim the insured
  • 3. ________________________________________Construction Law Newsletter Issue 41. Page 3will be paid by dividing the amount of insurancethe insured did carry by the amount that theinsured was required to carry at the time of loss.AMOUNT THE INSURER ACTUALLYCARRIED (DID CARRY)/AMOUNT THE INSURER IS REQUIREDTO CARRY (SHOULD CARRY) = Y%Continuing with the example above, if theinsured was required to carry a minimum of$450,000 but was only carrying $400,000 ofinsurance (in other words, the construction projectwas underinsured), then the “Y” percentage of theclaim the insurance company will pay is 88.9%($400,000/$450,000 = 88.9%).The second calculation applies thispercentage to the insurance claim amount:AMOUNT OF INSURANCE CLAIM * Y%In our example, if the amount of damage orloss being claimed is $300,000, then the insurancecompany will only pay 88.9% percent of theclaim: $266,700. This translates into a penalty of$33,300 for the insured as a result of not carryingthe amount of insurance required by thecoinsurance clause.Sometimes there is a conflict betweenother portions of the policy and the coinsuranceclause or an ambiguity in the coinsurance clausethat could benefit the insured. In that event,coverage counsel may be needed to advocate forthe interests of the policyholder.4. Reducing the Risk of a CoinsurancePenalty In a Builder’s Risk Policy.There are many things an insured can do toavoid a coinsurance penalty. A major difficultywith coinsurance clauses is that they apply basedon property value at the time of the loss, not whenthe policy is created or issued. To minimize thelikelihood that an insured will be penalized by acoinsurance clause, it is crucial that the builder’srisk insurance policy limit is as accurate aspossible with regard to value.When property is under construction, thevalue of the property generally increases, and mayeven increase beyond what was anticipated whenthe insurance was purchased. Therefore, the valuemust be regularly monitored and the insurancepolicy adjusted if necessary to accurately reflectthe property’s value. Otherwise, if a loss occursand the value stated in the insurance policy doesnot match the value of the property at the time ofthe loss, the minimum insurance amount indicatedin the coinsurance clause may not be met. Thiswill cause the coinsurance clause to take effect andpenalize the insured. Immediately reporting costoverruns so that the insurance policy limit may beraised will reduce the likelihood of underinsuranceat the time of loss. The amount of any increasedpremium will usually be much less than theamount of the potential coinsurance penalty.When reviewing and updating the policylimit of a builder’s risk insurance policy, it isimportant to consider replacement costs andmarket value. Replacement cost estimates areinfluenced by the supply of labor, demand forlabor, and costs of construction materials. Marketvalue fluctuates with the economy. A decrease inmarket value, as a result of an economic downturn,may not necessarily reflect a decline in theconstruction or rebuilding costs.Unless the construction is substantial,policyholders should avoid using the constructionloan amount as the limit of property insurance.The amount of the construction loan is usually lessthan the completed value of the property.Therefore, using the construction loan amount mayresult in the coinsurance penalty kicking in if thereis a loss.Finally, insureds may reduce theirlikelihood of having to pay a coinsurance penaltyby including overhead and profit in the completedvalue. If overhead and profit are omitted from thecalculation of completed value, they couldpotentially account for a serious coinsurancepenalty. The insurance policy must be examinedcarefully; however, be warned that some insurancepolicies instruct policyholders to exclude overheadand profit from the completed value calculation.
  • 4. ________________________________________Construction Law Newsletter Issue 41. Page 45. Policy “Adders” to Mitigate theCoinsurance Problem.If coinsurance is a concern, the insuredmay want to contract around it. Insureds mayrequest optional coverage to waive the coinsuranceclause. An Agreed Amount Clause, AgreedAmount Endorsement, or Agreed Value OptionalCoverage suspends the coinsurance clause whenthe insured carries the amount of insurance that theinsurance company and the insured agree to be theproperty’s actual value. Many insurancecompanies provide this option at an additionalcharge.Inflation Guard Coverage is anothercoverage option that may reduce the risk ofunderinsurance. Inflation Guard Coverageautomatically increases the amount of insuranceannually by a percentage indicated in thedeclarations. This allows the insurance policylimit to increase with construction cost increasesand relieves insureds from regularly monitoring,updating, and reporting to their insurance companyconstruction costs increases.CONCLUSIONAlthough coinsurance clauses create a riskfor policyholders that a claim may not be paid infull, there are various ways to reduce that risk.Exploring and carefully selecting the form ofbuilder’s risk insurance, incorporating andnegotiating optional coverage mechanisms towaive or reduce the risk of underinsurance, andregularly adjusting the insurance limit to reflectincreases in the property’s value will helppolicyholders avoid a coinsurance penalty kickingin.RECEIVERS: A POTENTIAL SOLUTIONTO A DISTRESSED PROJECTLaurie HagerSussman ShankHere is an increasingly common scenario.A developer borrows millions of dollars fromLender Bank to finance the construction of a high-end condominium project. The developer owesmillions of dollars to contractors and suppliers,who have asserted lien claims against the project.The developer defaults on the construction loanand cannot pay its contractors and suppliers.Before the project is even completed, contractorsand suppliers begin to file lawsuits in state court toforeclose their lien claims. Lender Bank filescross and counterclaims to foreclose its trust deed.The unfinished project poses code andsafety violations, and may become damagedduring the pendency of the complex foreclosureproceedings. Until the project is foreclosed andsold by the sheriff, the developer still owns theproject, but has no financial ability to complete orsecure it. The project, in its current unfinishedcondition, is worth less than the value of all theliens and trust deed debt. What can be done topreserve the project asset to maximize paymentunder the lien claims and trust deed?Lender Bank should consider moving thecourt for appointment of a receiver. Arguably anyvalid lien claimant with an interest in the projectcan provisionally move for the appointment of areceiver under ORCP 80B(1), in order to protectits interest in the project. Lender Bank, however,is presumably the party with the most at stake andthe best financial ability to advance thereceivership costs, which typically are paid to thereceiver prior to the sale of the property.Generally, the authority for appointment ofthe receiver and procedural steps are set out underORCP 80, and are likely provided for underLender Bank’s trust deed. Since Oregon does nothave a statute outlining powers and
  • 5. ________________________________________Construction Law Newsletter Issue 41. Page 5responsibilities of a receiver (compare toWashington’s Chapter RCW 7.60), a carefullycrafted receivership order is needed to outline thereceiver’s powers and responsibilities, subject tofurther order or instructions from the court.Under the authority of the court’s order,the receiver can take measures to protect theproject that the developer cannot afford to do andthat Lender Bank and other lien claimants do nototherwise have legal authority to do. For instance,the receivership order can authorize the receiver tosecure the project site from intruders, maintainbuilding code compliance, and make necessaryrepairs. Additionally, the receivership order cangrant the receiver authority to retain contractorsand suppliers to complete the unfinished work andincrease the value of the project prior to theforeclosure sale. Moreover, if the receivershiporder authorizes the receiver to sell the property,the receiver may be able to obtain a better price forthe project than if sold at a sheriff’s sale, thusincreasing the amount of money Lender Bank andlien claimants will receive under their respectivetrust deed and lien foreclosure claims (after sortingout priorities).If you represent a secured party involved ina complex, distressed construction project, youmay want to consider whether seeking areceivership order is an appropriate remedy tomaximize payment opportunities from the project.NEW RULING CONCERNINGCONTRACTOR LICENSING AND LIEN RIGHTSShannon Raye MartinezSaalfield GriggsIn recent years, the ConstructionContractors Board (“CCB”) has fined hundreds ofcontractors for failing to follow CCB licensingrequirements. Many of these licensing issues relateto the type of work performed by the contractorand the question of who holds the constructionlicense. In Hooker Creek Companies, LLC v.Remington Ranch, LLC, Case No. CV-11-090-MO(D. Or. June 9, 2011), these very issues causedOregon District Court Judge Mosman to invalidatea construction lien for over five million dollars.This case is currently on appeal before theU.S. Court of Appeals for the Ninth Circuit, CaseNo. 11-35566, and if upheld, Judge Mosman’sthorough analysis of the text of Oregon’s licensingstatutes in this case could have far reachingeffects.Facts of the Case and Procedural History:Remington Ranch, LLC (“Remington”) isthe developer and owner of the Remington Ranchproject, a multi-million dollar destination resort inPrineville, Oregon. In January of 2010, Remingtonfiled Chapter 11 bankruptcy. Prior to thebankruptcy filing, Hooker Creek Companies, LLC(“HCC”) filed a claim of construction lien for over$5 million for labor, materials, services andequipment provided to the Remington Ranchproject. HCC also filed a lawsuit in Crook CountyCircuit Court to foreclose its lien. After thebankruptcy was filed, Remington and the lenderfor the project challenged HCC’s lien in theBankruptcy Court on the basis that HCC was notentitled to claim a lien and that it was not properlylicensed with the CCB.HCC was the parent company to severalsubsidiary construction companies, includingHooker Creek Asphalt & Paving, LLC (“HCAP”).HCC argued that, although it was the generalcontractor for the project, it was the materialsupplier only and did not provide any of the laborfor the Remington Ranch project. HCC’s work onthe Remington Ranch project related to initialexcavation, road work and infrastructure work.HCC claimed that all labor was provided byHCAP. The construction contract ambiguouslyprovided that “Hooker Creek” was the contractingparty.Although an addendum to the contractnamed HCC as the general contractor, HCCapplied for a license with the CCB after it filed itsclaim of construction lien, but before it filed suit
  • 6. ________________________________________Construction Law Newsletter Issue 41. Page 6to foreclose its lien. HCAP was licensed with theCCB well before the construction contract wassigned.Judge Perris of the U.S. Bankruptcy Courtfor the District of Oregon invalidated HCC’sconstruction lien on the grounds that the companywas not properly licensed under ORS 701.131, andtherefore, was not entitled to a valid constructionlien. See Remington Ranch, LLC v. Hooker CreekCompanies, LLC, Case No. 10-3093-elp (Bankr.Or. 2010). HCC then appealed Judge Perris’opinion and order to the U.S. District Court.Issues:None of the parties disputed that HCC wasnot licensed prior to filing its construction lien.HCC argued four points: (1) it was not acontractor required to obtain a license under ORS701.131(1); (2) if the court found it was a“contractor,” then HCC qualified for the safeharbor under ORS 701.131(2)(a)(B) because itobtained a license before it foreclosed its lien; (3)HCAP’s license should be attributed to HCCbecause HCAP is a wholly owned subsidiary; and(4) at a minimum, the materials, equipment andservices portion of the lien should be held valid,since a license is not required for these types ofconstruction services.ORS 701.131(1) requires all “contractors”to be licensed with the CCB at the time ofcontracting for the work, and continuously duringthe performance of the work. An importantstatutory consequence of a contractor’s failure tomeet the licensing requirements is the prohibitionagainst perfection of a construction lien.In ORS 701.005(5)(a), a “contractor” isdefined as, “a person that, for compensation orwith the intent to sell, arranges or undertakes oroffers to undertake or submits a bid to construct,alter, repair, add to, subtract from, improve,inspect, move, wreck or demolish, for another, anybuilding, highway, road, railroad, excavation orother structure, project, development orimprovement attached to real estate, or to do anypart thereof.”Holding and Effect on Oregon ConstructionLaw:Judge Mosman disagreed with HCC, andinvalidated its entire claim of construction lien asa matter of law. This decision may seem simple onits face – HCC contracted to provide labor, andwas not properly licensed. However, JudgeMosman’s opinion analyzes ORS 701.131 in moredetail than any prior case, and potentially impactsthe future interpretation of this statute in general.Judge Mosman quickly dispelled HCC’sargument that it qualified for the safe harbor underORS 701.131(2)(a)(B), and found that the statuterequires a contractor to obtain the license prior toperfecting its construction lien. Additionally,Judge Mosman determined that HCAP’s licensecould not be attributed to HCC because Oregonlaw clearly prevents the performance ofconstruction work through another entity’s license.See OAR 812-003-0100Judge Mosman focused his analysis on thetext of ORS 701.131(1), and HCC’s argumentsthat it was not a “contractor,” and was thusentitled to a lien for materials, services andequipment. Ultimately, by looking at the interplayof the text of ORS 701.010(3), 701.005(5)(a) andORS 701.131(1), Judge Mosman held that HCCmust be considered a “contractor” for the entireproject, and may not exempt portions of its workfrom the licensing requirements.ORS 701.131(1) states that a contractormay not perfect a construction lien for “worksubject to this chapter.” Judge Mosman interpretedthis provision to mean that an unlicensed“contractor” simply may not perfect a constructionlien, regardless of whether any specific workperformed was “subject to this chapter.” In thiscase, HCC was a “contractor” under ORS701.005(5)(a) because HCC did not simplyprovide materials without fabricating them into theproject, and thus did not qualify for any of theexemptions to licensure in ORS 701.010.Prior to Judge Mosman’s ruling, it seemedapparent that CCB regulations and Oregon statutesrequired contractors to be separately licensed, and
  • 7. ________________________________________Construction Law Newsletter Issue 41. Page 7general contractors could not rely on the licensesof their affiliated companies or subcontractors.Judge Mosman’s decision confirms this andfurther clarifies that an unlicensed contractor couldlose its lien rights for all work provided under thecontract, even if not performed by such contractorand including the materials and equipment rentalprovided by the contractor.Additionally, it is important to note thatJudge Mosman’s ruling is limited to constructionliens. Judge Mosman found that ORS 701.131(1)is “not a restriction of a party’s right to sue ingeneral, but instead limits only the extraordinaryprivileges bestowed on those who strictly complywith the requirements of lien perfection.” As aresult, the question remains as to whether acontractor who fails to meet the CCB licensingrequirements would still have the right to sue forbreach of contract for all or part of the work, eventhough they would lost their right to a constructionlien for any of the work provided.PORTLAND’S DISPARITY STUDYJames Van DykeChief Deputy City AttorneyCity of Portland1The City of Portland and PortlandDevelopment Commission (PDC) hired aconsultant in 2009 to conduct a “disparity study”concerning the City’s and PDC’s constructioncontracts and their construction-relatedprofessional service contracts.A disparity study is a court-approvedmethod to help public agencies decide whetherthere is a legal basis for programs to assist1Portions of this article were based on research andcase summaries provided by Holland & Knight, LLP.The author acknowledges and appreciates itscontribution. The comments in this article reflect mypersonal opinions and do not represent official policyof the City of Portland.minority and women owned businesses (hereafter“MBEs” and “WBEs” and collectively“M/WBEs”). Such studies compare theavailability of M/WBEs in the local geographicarea to their actual use and then determine if thereis a legally significant disparity between those twofigures. In the absence of such a study, publicagencies do not have legally sufficient evidence toestablish race conscious measures and must ensuretheir actions are race and gender neutral. Whatfollows is a general overview of the law in regardto disparity studies followed by a generalizeddiscussion of the study’s results.As you are aware, government efforts tohelp MBEs and WBEs over the past three decadeshave resulted in a multiplicity of lawsuits as wellas a voluminous number of court decisions andlaw review articles. It is beyond the scope of thisarticle to differentiate between federal, state andcity affirmative action programs, the differentlegal standards that may be applicable to each orthe variety of approaches used by differentconsultants when conducting such studies.Nonetheless we can make some generalizations.The starting point for legal analysis is Cityof Richmond v. J.A. Croson Co., 488 US 469(1989), in which the Court invalidatedRichmond’s minority contracting preference planunder the Equal Protection Clause of the 14thAmendment. The Richmond plan required primecontractors to ensure at least 30 percent of thecontract dollars went to one or more MBEs.Applying a standard of “strict scrutiny,”the court held the plan violated the EqualProtection Clause because Richmond lackedsufficient evidence to show it had become a“passive participant” in a system of racialexclusion practiced by some in the localconstruction industry. In the absence of sufficientevidence, the Richmond failed to prove it had a“compelling governmental interest” to take raceconscious measures to address the perceivedproblem. In addition, the court found Richmond’splan was flawed because it was not “narrowly
  • 8. ________________________________________Construction Law Newsletter Issue 41. Page 8tailored” to remedy that discrimination.2Since Croson, disparity studies havebecome the principal method to develop proof thatthe government’s contracting process has beentainted by unlawful racial discrimination. The twomain components of a disparity study are 1)statistical data and 2) anecdotal information. Thestatistical portion of the study gathers and analyzesdata showing the availability and utilization ofM/WBEs in the local market area. The anecdotalportion of the study consists of interviews withpersons in the construction industry to determine ifthey have experienced racial discrimination.“Narrowtailoring” includes consideration of race andgender neutral measures.The data showing availability andutilization is analyzed to determine if there is astatistically significant disparity between theavailability of M/WBEs in the marketplacecompared to their actual utilization. If asignificant disparity exists and that disparity iscoupled with anecdotal evidence showingdiscrimination, courts permit an inference ofdiscriminatory exclusion from the marketplace andpermit the government to take appropriate, but“narrowly tailored” remedial action.What amount of disparity is statisticallysignificant? Some courts have found astatistically significant disparity when a minoritygroup receives 80% or less of the expected amountof contracts dollars it otherwise should receivebased its presence in the marketplace. RotheDevelopment Corp v. US Department of Defense,545 F3d 1023 (Fed. Cir. 2008). In other words, ifMBEs should receive 10% of all contract dollarsbased on their availability in the marketplace andthey receive less than 8%, that difference (20%) isstatistically significant.Data gathering for M/WBE utilization isrelatively straightforward since it depends onhistorical records showing to whom contracts andsubcontracts were awarded. This portion of the2While racial programs may be subject to “strictscrutiny”, programs addressed to gender may besubject to “intermediate scrutiny.”study may be time-consuming, but is notanalytically difficult.Data gathering and analysis of data todetermine MBE availability is more complex. Todetermine “availability,” the City’s and PDC’sconsultant used an “enhanced custom census”approach. First, historical data was used todetermine the geographic areas from which theCity and PDC draws its contractors, which wasdetermined to be five Oregon counties and twoWashington counties.3Third, the consultant attempted to conducttelephone interviews with all of the firms on thelist created through Dun & Bradstreet records. Ofthe 8,130 firms listed, approximately 5,900 hadaccurate, working telephone numbers, and contactwas successfully made with 3,726 firms. Of thosefirms, 1,700 stated they were not interested inparticipating in an interview. The remaining 2,000firms were interviewed. The interviews concernedsuch topics as interest in, and capacity for, Cityand PDC projects, firm qualifications, firmspecialization, the largest contract performed inthe past five years, the length of time in business,and the racial, ethnicity and gender makeup offirm ownership. Only firms that consented to haveinterviews were used to generate data for theactual study.Second, the consultantobtained information from Dun & Bradstreet onall businesses using the 8-digit industry codesmost related to City construction and construction-related professional services contracts andsubcontracts. That effort produced approximately8,130 listings.Next, the consultants took that informationand performed an analysis of the “relativecapacity” of MBE and WBE firms. Relativecapacity refers to the ability of a firm to take onwork. Clearly, smaller firms have less capacity totake on large projects, or multiple small projectssimultaneously, than larger firms and thus are less“available.” Studies that fail to take “relative3The relevant market area was comprised ofColumbia, Washington, Yamhill, Clackamas,Multnomah, Clark and Skamania counties.
  • 9. ________________________________________Construction Law Newsletter Issue 41. Page 9capacity” into account have been criticized bysome courts as insufficiently reliable. Rothe,supra.The result of this “relative capacity”analysis was a decrease in overall availability forMBE and WBE firms when compared to theirpresence in the marketplace. For example, initialinterviews showed that the total number of MBEfirms in the area comprised 5.7% of the marketwhile WBE firms (white women owned only)comprised 12.9% of the market, for a combinedtotal of 18.6%.After relative capacity was taken intoaccount, however, the actual availability of MBEfirms across the entire spectrum of City primecontracts dropped from 5.7% to 1.9%. It isimportant to remember that availability based on“relative capacity” is a “dollar weighted” average,which takes contract size into account.4The average availability of MBEs over theentire spectrum of City contracts, however, is notthe only picture presented by the data. Forexample, while the average availability for MBEcontractors over all City contracts was 1.9%, theavailability for all subcontracted work was foundto be 4.8%. Thus, there are far more availableMBEs for subcontract work on City projects thanthe average availability numbers portray.Critics of the “relative capacity” approachto determining availability note that MBE firmsmay be smaller and unable to perform a greaterquantity of work as a result of historical or currentracial discrimination. That, of course, may well betrue. Until the Supreme Court or other circuitcourts reach different conclusions, however, it4The study separated PDC and the City whendetermining availability. The data in this article refersto availability for City contracts only. Availability andusage for PDC contracts was different. This shouldnot be surprising since the City and PDC undertakedifferent types of contracts. PDC is focused on urbanrenewal and often is involved with the development ofproperty. The City has far more sewer and watercontracts, road contracts and other infrastructurecontracts than PDC.appears prudent for disparity studies to at leastaccount for relative capacity in their conclusions.5Indeed, the Supreme Court’s decision inCroson to focus on current statistical data appearsto reflect a judgment to take the playing field as itis found as opposed to where it “would” be ifdiscrimination had never existed. If one cannotpresume racial discrimination held down theavailability of MBEs in the heart and capital of theConfederate States of America, it seems unlikelythe Supreme Court will do so elsewhere.PDC and the City currently are examiningthe results of their disparity studies. Generallyspeaking, City results showed some disparities forcertain prime contracts and for certainsubcontracts in certain, but not all, categories ofcontracts, such as contracts awarded withoutapplication of the City’s current Good FaithEfforts program.6In contrast, PDC’s results showedstatistically significant disparities in its“sponsored” construction projects. Sponsoredprojects are those where PDC provided financialsupport or loans to a developer, but did notactually execute the construction contract.As a result of the disparity study, the Cityand PDC, together with citizen advisory groups,are in the process of examining a wide range of itsexisting procedures and policies to see if the Citycan remove barriers to the entry and advancementof MBE and WBE firms. It is anticipated thatchanges to City programs, and new programs, maybegin to take shape beginning after February of2012.In summary, my best guess is that you willsee changes to City programs designed to assistMBE and WBE firms next year because thedisparity study shows there has been statisticallysignificant disparity in the contracts awarded to5I am not a statistician so there may be other analyticalmethods to take this into account.6The Good Faith Efforts program requires contractorsto make good faith efforts to give opportunities tominority and women owned businesses by contactingthem in advance of submitting a bid.
  • 10. ________________________________________Construction Law Newsletter Issue 41. Page 10MBE and some WBE firms and those awarded tomajority-owned firms. The extent of thosechanges, for now, remains undetermined. Asthose programs come into shape I will give you anupdate on what to expect from the City’s biddingand contract process.CHANGES TO THE CCBDISPUTE RESOLUTION SERVICESWilliam J. BoydOregon Construction Contractors BoardOn July 1, 2011 the ConstructionContractors Board (CCB) Dispute ResolutionServices (DRS) program changed dramatically.This change was necessary because of the recentsharp slowdown in construction that resulted in asignificant drop in the number of licensedcontractors and the fees paid to the CCB. Toadjust to this drop in revenue, the legislature madesignificant cutbacks in the CCB’s budget for theDRS program. In order to accomplish this, thelegislation eliminated the cost to send DRS files tothe Office of Administrative Hearings for acontested case hearing or arbitration if a partychallenged an order issued by the CCB. Thestatutory amendments necessary to accomplish thisare in Senate Bill 939, sections 38 through 73.For complaints filed on and after July 1,2011, DRS will provide only mediation services.If the parties do not settle the complaint, thecomplainant must go to court and obtain a courtjudgment before DRS can send it to thecontractor’s surety for payment (that process mayinvolve a contractual arbitration). Essentially, theCCB is using the court system to establish liabilityand damages, rather than an administrative processbacked up with an administrative hearing.Processing CCB complaints is relativelyunchanged through the on-site meeting where theCCB Investigator Mediator meets with the partiesat the job site to mediate the complaint andprepare a report of his or her observations if thecomplaint does not settle. If the complaint doesnot settle, the parties must go to court and theCCB will base its decisions on the resultingjudgment.Agency staff still must determine if thecomplaint is within the CCB’s jurisdiction andhow much of the judgment should be paid by thecontractor’s bond. To avoid hearings on theseissues, the legislation provided that these decisionsare orders not in a contested case. This type oforder may be challenged in circuit court, ratherthan in an administrative hearing. (See OregonAttorney General’s Administrative Law Manual,Part V, 192 – 202 (January 1, 2008). Agency rulesprovide that the party challenging this kind ofCCB order must file a petition for reconsiderationbefore filing in circuit court. OAR 812-004-1260.To implement SB 939, the CCB adoptedamendments to its administrative rules. Most ofthe new rules are in OAR 812-004-1001 through1600.See also the following article by AlanMitchell on these changes.SIGNIFICANT CHANGES TO THE CCBDISPUTE RESOLUTION PROGRAMAlan MitchellMitchell Law Office2011 Senate Bill 939 has made significantchanges to the Dispute Resolution Program of theOregon Construction Contractors Board (CCB).This article discusses some of those changes. Formore information, check the CCB’s web site.Sections 38 through 73 of this bill set outmajor changes to the CCB’s Dispute Resolutionprocedures. The bill was passed on July 6, 2011and took effect that date. Section 54 expresslystates a legislative intent that these statutorychanges may be applied retroactively in order toprocess CCB complaints filed on or after July 1,2011.
  • 11. ________________________________________Construction Law Newsletter Issue 41. Page 11Prior to this bill, processing a CCBcomplaint first involved an on-site mediation andinvestigation. If that did not lead to a settlement,then the CCB would issue a proposed order and,frequently, refer the complaint to the Office ofAdministrative Hearings (particularly if one of theparties wanted to contest the proposed order).Under this bill, the second and third steps havebeen eliminated. Thus, the CCB complaint processnow is essentially a “mediation-only” program.For CCB complaints filed on or after July1, 2011, ORS 701.145(5) has been amended toprovide that, if the parties do not settle a complaintunder CCB-assisted mediation efforts, then thecomplainant must file a circuit court action (whichcould be a small claims action) or an arbitrationagainst the contractor. Once the complainantobtains a final judgment (which could includeconverting an arbitration award into a judgment),the CCB will issue a determination ordering thecontractor’s surety to pay that portion of thejudgment that is within the CCB’s jurisdiction.Those determinations will be orders that are notcontested case orders.One additional change is that the CCB willnow conduct mediations for all complaints, notjust owner versus prime contractor disputes. In thisregard, the bill expressly authorizes telephonemediations (new ORS 701.145(4)).Yet another impact of these changes is thata CCB Final Order can no longer be recorded tocreate a judgment lien (again, this is forcomplaints filed on or after July 1, 2011). This isbecause the CCB will not be issuing those orders.That ability had been set out in ORS 701.153,which cross-referenced ORS 205.125 and 201.126.Two other impacts of these changes are therepeal of ORS 701.148 (which allowed the CCB torequire that OAH hearings were held asarbitrations – since there are no OAH hearings,this is no longer needed) and ORS 87.058 (whichallowed a property owner, in certain situations, toobtain a stay of a construction lien foreclosureaction by filing a complaint with the CCB – nowthat CCB complaints will be decided judicially,there is no reason for this procedure).Practitioners should also note that many ofthese changes have a “sunset” date of July 1, 2017.Thus for CCB complaints filed on or after July 1,2017, Sections 56 through 72 of SB 939 reinstatemost of the laws in effect prior to July 1, 2011,including the CCB’s ability to use the Office ofAdministrative Hearings and the ability of anowner to obtain a stay of a construction lienforeclosure action.CASE LAW UPDATESD. Gary ChristensenJeffrey SagalewiczMiller Nash1. ARBITRATION: PUBLIC POLICYFAVORING BINDING ARBITRATION OFDISPUTES REQUIRES THAT ANAMBIGUOUS ARBITRATIONAGREEMENT BE INTERPRETED ASBINDING, ABSENT OTHER EVIDENCE OFTHE PARTIES’ INTENT.Gemstone Builders, Inc. v. Stutz, 245 Or App 91(2011).Plaintiff contractor sued defendant ownersfor breach of contract, unjust enrichment, andfraud. Defendants moved to compel arbitrationunder the construction contract, but the trial courtdenied defendants’ motion. Defendants appealed,and the Court of Appeals reversed.The Court of Appeals analyzed thelanguage of the contract to determine whetherthere was an agreement to arbitrate the dispute andwhether any arbitration clause was binding.Plaintiff argued that the contract languagereferring to arbitrating disputes was inconsistent,and thus should not be enforced. For example,plaintiff argued that the contract’s attorney feeclause, which stated that “[i]f there is cause forsuit, dispute, or action, both parties agree tosubmit to arbitration * * * prior to entering intothe case of suit” was incompatible with terms in
  • 12. ________________________________________Construction Law Newsletter Issue 41. Page 12which the parties agreed that the contractor couldpursue any remedy afforded at law or in equity forstrict foreclosure. But the Court of Appeals readthe latter term as referring to remedies only, notthe proper forum to pursue the remedy.The Court of Appeals also rejectedplaintiff’s argument that if the language of theattorney fee clause were intended to apply to alldisputes, then the parties’ agreement in thewarranty section of the contract that required themto first submit any warranty dispute to arbitrationwould be rendered redundant. But any resultingredundancy did not create an ambiguity for theCourt of Appeals.Having decided that the agreement toarbitrate was unambiguous, the court consideredwhether the agreement to arbitrate was binding.Several clauses in the contract referred toarbitrating disputes “prior to” initiation of any suit,suggesting that the agreement was not binding.But the attorney fees term also specifically statedthat decisions from the arbitrator would be bindingon both parties.Because the provisions are inconsistentwith each other, the Court of Appeals held that thecontract was ambiguous. But it was not tooambiguous to enforce. Instead, because the recordcontained no extrinsic evidence of the parties’intent concerning binding arbitration, the courtturned to maxims of construction to resolve theambiguity. The court found clear policies favoringarbitration as an alternative to litigation and not astep to prolong it. Based on these policies, theCourt of Appeals held that the ambiguity would beresolved in favor of binding arbitration.Accordingly, the trial court erred when it failed tocompel binding arbitration.2. ATTORNEY FEES: A PREVAILINGDEFENDANT MAY RECOVER ATTORNEYFEES UNDER A PREVAILING PARTYATTORNEY FEE CLAUSE EVEN IF ATHIRD PARTY IS BILLED FOR THE FEESAND PAYS THEM UNDER A SEPARATEAGREEMENT WITH THE DEFENDANT.Menasha Forest Products Corp. v. Curry CountyTitle, 350 Or 81, 249 P3d 1265 (2011).Plaintiff Menasha Forest ProductsCorporation filed a declaratory judgmentconcerning a title insurance policy issued byTransnation Title Insurance Company in connectionwith an escrow closed by Curry County Title, Inc.(“CCT”). Menasha’s escrow contract with CCTincluded a prevailing party attorney fees clause thatapplied to all claims arising out of the escrow. CCTand Transnation were jointly represented in defenseof the action and, under a separate indemnificationagreement between the CCT and Transnation,Transnation was billed and paid all attorney fees inconnection with the action.Ultimately, defendants prevailed on thedeclaratory judgment action, and the trial courtawarded them attorney fees jointly. The Court ofAppeals reversed, accepting Menasha’s argumentthat CCT was not entitled to recover fees because itdid not expend or incur any fees in defense of theaction. Transnation had paid the attorney fees and,because of the indemnification agreement, CCTwas not liable to pay them in the first place.CCT and Transnation appealed to theOregon Supreme Court who agreed with the trialcourt. The court rejected Menasha’s argument thatCCT was required to show that it had paid or wasrequired to pay attorney fees in defense of the actionin order to recover them under the contractlanguage. Instead, the Supreme Court identifiedthat CCT’s entitlement to attorney fees must beanalyzed separately from the indemnity agreementbetween CCT and Transnation. The court went onto hold that CCT incurred attorney fees because itwas liable to pay them notwithstanding theindemnity agreement. For example, hadTransnation not paid the attorney fees under theindemnity agreement, CCT was still liable to the
  • 13. ________________________________________Construction Law Newsletter Issue 41. Page 13attorney for those fees. Menasha was not entitled tothe benefit of the indemnification agreement.The court also rejected Menasha’s argumentthat Transnation was not entitled to a joint award ofattorney fees because it was not a party to theescrow agreement. The court found, however, thatthe relationship between Transnation and CCT withrespect to the issuance of the title policy was one ofprincipal and agent. As such, Transnation was aproper party to enforce the attorney fee right in thecontract, particularly given that Menasha set forthno evidence that the agency relationship betweenTransnation and CCT did not extend to enforcingthe escrow agreement.3. ATTORNEY FEES/INSURANCE:ATTORNEY FEES MAY BE AWARDEDUNDER ORS 742.061 ONLY AGAINSTINSURERS WHO DELIVER THEIRINSURANCE POLICY OR ISSUE IT FORDELIVERY IN OREGON.Morgan v. Amex Assurance Co., 242 Or App 665(2011).Attorney fees against insurers may beawarded when claims are not settled within sixmonths after proof of loss is filed underORS 742.061. However, that statute is subject toORS 742.001, which limits that chapter’sapplication to “insurance policies delivered orissued for delivery in” Oregon. In an automobileinsurance claim action in which judgment wasissued against the insurer and in favor of anOregon plaintiff arising from an automobileaccident in Oregon, the trial court held that noattorney fees could be awarded to the plaintiffbecause the defendant was a Washington residentwhose Washington insurance policy had beendelivered to her in Vancouver. The court ofappeals affirmed, finding that ORS 742.061 iscontrolled by ORS 742.001, including itslimitation of application to Oregon insurancepolicies.4. DAMAGES: EXTENDED HOMEOFFICE OVERHEAD DAMAGES AREDISTINCT FROM UNABSORBED HOMEOFFICE OVERHEAD DAMAGES ANDEXPERT OPINION BASED ON THEEICHLEAY FORMULA CANNOT BE USEDTO ESTABLISH EXTENDED HOMEOFFICE OVERHEAD DAMAGES.Stellar J Corp. v. Smith & Loveless, Inc., 2010 WL4791740 (D Or Nov 18, 2010).In a federal breach-of-contract action inwhich the general contractor plaintiff soughtrecovery from a subcontractor defendant for“extended home office overhead” damages, thesubcontractor filed a motion for partial summaryjudgment against those damages and prevailedbefore the Magistrate Judge. On review, thedistrict court affirmed the grant of partial summaryjudgment dismissing the claim for overheaddamages because plaintiff had asserted a claim forextended home office overhead losses but itsexpert had supported that claim by application ofthe Eichleay formula, which is used to calculate“unabsorbed” home office overhead losses. Thegeneral contractor failed to show that its home-office overhead was not a fixed expense or that itactually suffered additional home-office overheadexpenses due to the subcontractor’s delay in itswork.The court distinguished unabsorbed andextended overhead claims, noting that to recoverextended home-office overhead costs, the generalcontractor was required to show “added overheadcosts, which exceed its normally incurred fixedexpenses attributable to ongoing businessoperations [because] * * * a contractor may still beable to complete the work without incurring‘added’ overhead costs” (quoting West v. All StateBoiler, Inc., 146 F3d 1368, 1378-79 n4 (Fed Cir1998).The district court further held that it wasappropriate for the court to adjudicate only aportion of the contractor’s damages claim viasummary judgment, rather than the entire damagesclaim, under Fed R Civ P 56.
  • 14. ________________________________________Construction Law Newsletter Issue 41. Page 145. INSURANCE/ADDITIONALINSURED: THE “FOUR CORNERS” RULEIS INAPPLICABLE TO DETERMINEWHETHER THE PARTY SEEKINGCOVERAGE IS IN FACT AN “INSURED”PARTY UNDER THE POLICY.Fred Shearer & Sons, Inc. v. Gemini Ins. Co., 237Or App 468 (2010), rev den., 349 Or 602 (2011).A stucco manufacturer’s liability insurancepolicy purported to cover distributors under a“vendors endorsement” for all “vendors of the[manufacturer],” but “only with respect to ‘bodilyinjury’ or ‘property damage’ arising out of ‘yourproducts’ * * * which are distributed or sold in theregular course of the vendor’s business.” Ahomeowner sued its general contractor for lossesresulting from leaking and mold caused by crackedstucco. The general contractor, in turn, broughtthird-party claims against the subcontractor thathad sold and installed the stucco and against thestucco manufacturer. The subcontractor was adistributor of the manufacturer’s stucco product.The manufacturer’s insurer, Gemini Insurance,however, denied the subcontractor’s tender ofdefense under the policy. In a declaratoryjudgment action to determine Gemini’s duty todefend, the trial court held that the subcontractorwas an insured under the vendor’s endorsementand Gemini appealed.On appeal, Gemini did not dispute thesubcontractor’s status as a distributor but claimedthat the facts necessary to establish that it fellwithin coverage under the vendors endorsementcould not be found within the “four corners” of thecomplaint, third-party complaint, or insurancepolicy. It objected to extraneous evidence used toestablish the subcontractor’s status as an insured,relying on the familiar recitation of the “four-corners rule” in Ledford v. Gutoski, 319 Or 397(1994). The Court of Appeals rejected thesubcontractor’s apparent concession that the four-corners rule applied and held that that rule has noapplication in determining the preliminaryquestion whether the subcontractor was an“insured” under the policy at all. The question ofinsured status under a policy is analytically distinctfrom whether the alleged losses are covered by thepolicy. The homeowner and general contractor, toproperly plead their claims, need not plead factsrelating to the subcontractor’s relationship withthe manufacturer’s insurer or its status under themanufacturer’s insurance policy.The considerations underlying the four-corners rule have no application to the preliminaryquestion of a party’s status as an insured under thepolicy. Looking to the stipulated facts before thecourt, including extrinsic facts, the court affirmedthe trial court’s declaration that the subcontractorwas an insured under the vendor endorsement.The court went on to determine coverage of theclaims (applying the four-corners rule) andaffirming the allocation of defense costs toGemini.6. INSURANCE/ASSIGNMENT OFCLAIM: AN EXCESS POLICY OFINSURANCE “FOLLOWS FORM” TO THEUNDERLYING PRIMARY POLICY ONLYTO THE EXTENT THAT ITUNAMBIGUOUSLY INCORPORATES ITSTERMS. ALSO, AN INSURED MAYVALIDLY SETTLE WITH A CLAIMANT BYASSIGNING THE INSURED’S RIGHTSAGAINST ITS INSURER, WHO HASDENIED THE CLAIM, UNDER ORS 31.825.Portland School Dist. v. Great American Ins. Co.,241 Or App 161, rev den. 350 Or 573 (2011).A contractor negligently caused a firewhile reroofing Binnsmead Middle School inPortland in 2003. The contractor’s primaryliability insurer settled to the limits of its coverage,leaving more than $1 million in damages to collectfrom the contractor’s excess liability carrier, whodenied the claim outright. The school district andcontractor entered into a settlement agreementunder which the school district would sue thecontractor in negligence for the remainingdamages and the contractor would stipulate toentry of a judgment against it, confessing itsnegligence. After entry of the judgment, thecontractor would, in exchange for a release, assign
  • 15. ________________________________________Construction Law Newsletter Issue 41. Page 15its rights against its excess insurer to the schooldistrict, who would then pursue recovery underthat policy. This process intended to follow therequirements of ORS 31.825, which permitsassignments of claims against insurers byjudgment-debtors in exchange for releases.When the school district sued the excessinsurer on claims obtained through the assignment,the insurer argued that (a) the excess policybenefitted from an anti-assignment provisionfound in the underlying primary insurance policythrough a “follow form” clause that purportedlyadopted the terms and conditions of the underlyingpolicy by reference, and (b) ORS 31.825 does notallow assignments of claims against insurersobtained through a pre-judgment settlementagreement with the insured. The Court of Appealsupheld the trial court’s judgment awarding theschool district judgment against the excess insurerfor the remaining damages.The excess policy did not use the term“follows form,” common insurance parlance forthe incorporation of coverage by an excess policy.Instead, it stated: “Except for the terms,conditions, definitions and exclusions of this[excess] policy, the coverage provided by thispolicy will follow the [underlying primary liabilitypolicy].” The trial and appellate courts found thatthis clause was not sufficiently clear to incorporatean anti-assignment clause that was located in the“terms and conditions” section of the primaryliability policy and not the “coverage” provisions.Because the language was ambiguous aboutwhether all of the terms or just the coverage termsof the underlying policy were to be incorporated, itapplied the maxim that the policy would beconstrued against the drafter.Additionally, the school district and insuredcontractor were held to have correctly followed therequirements of ORS 31.825 in the process set outin their settlement agreement. Although the partiescontemplated a suit and entry of a judgment in theagreement, no enforceable release was given to thecontractor and no enforceable assignment of rightswas given to the school district until after thejudgment against the contractor had been entered.Thus, the statute preserved the insured’s claimagainst the excess insurer in the hands of the schooldistrict.7. INSURANCE/BINDERS: A WRITTENINSURANCE POLICY MAY NOT EXCLUDECLEAR AND EXPRESS TERMS OF ANEARLIER ORAL BINDER.ADDITIONALLY, AN INSURED MAYRECOVER ATTORNEY FEES UNDER ORS742.061 IN CONNECTION WITH AN ORALBINDER OF INSURANCE.Stuart v. Pittman, 350 Or 410, 255 P3d 482(2011).In connection with building a new home,plaintiff purchased a course-of-constructioninsurance policy through defendant RonaldPittman, an insurance broker. Plaintiff requestedcoverage that would provide “safety net” or“catch-basin” coverage that would apply “in allinstances that something goes wrong duringconstruction.” Pittman agreed to procure thecoverage and did not communicate anylimitations. During the course of construction, astorm damaged plaintiff’s partially-completehouse. Although the storm occurred severalmonths after the oral binder of insurance wasgiven, the insurer had still not delivered a policy toplaintiff. Plaintiff made a claim on the policy andPittman told him that the damage should becovered. However, the written policy that waseventually issued to plaintiff included an exclusionfor the type of damage that plaintiff suffered, sothe insurer denied the claim.Plaintiff sued Pittman and the insurer forbreach of contract and prevailed at the trial court.On appeal, the Court of Appeals accepteddefendants’ argument that, under ORS 742.043,plaintiff’s request for “safety net” coverage wasnot sufficiently clear and express to supersede thewritten exclusions in the policy.Plaintiff appealed, and the Supreme Courtreversed. Under ORS 742.043, oral bindersinclude all the normal terms of the policy,including endorsements and exceptions except assuperseded by clear and express terms of the oral
  • 16. ________________________________________Construction Law Newsletter Issue 41. Page 16binder. Applying the analysis prescribed in PGEv. Bureau of Labor and Industries, the SupremeCourt held that to be sufficiently clear and express,terms of the oral binder must not be vague orobscure. Here, a request for “safety net” or“catch-basin” coverage in “all instances thatsomething goes wrong” was not vague or obscure;the language essentially referred to an “all-risk-policy.” Because there was evidence in the recordfrom which the jury could reasonably concludethat plaintiff had requested a policy different fromthat eventually expressed in the written policy, thetrial court did not err.The Supreme Court also affirmed the trialcourt’s grant of attorney fees under ORS 742.061.Defendants had argued that plaintiff was notentitled to attorney fees because the statute onlyapplied to written policies, not oral binders. Butthe Supreme Court rejected the argument on twogrounds. First, the jury’s conclusion that therewas an enforceable oral binder of insurance meantthat, under ORS 742.043, the written policy issuedby defendants was deemed to include all the termsof the oral binder. Second, the Supreme Courtrelied on prior precedent that allowed attorney feesunder oral binders.8. INSURANCE/DUTY TO DEFEND: ANINSURER’S DUTY TO DEFEND DOES NOTARISE WHEN THE ALLEGATIONS OFTHE COMPLAINT FAIL TOSPECIFICALLY PLEAD THAT THERESULTING DAMAGE COVERED BY THEPOLICY NECESSARILY RESULTED FROMTHE DEFECTS ALLEGED IN THECOMPLAINT.State Farm Fire & Casualty v. American FamilyMutual, 242 Or App 60, 253 P3d 65 (2011).Homeowners asserted a claim againstEdgewater Homes, Inc., for breach of contract,breach of implied warranties, and negligence arisingout of the construction of an EIFS cladding systemat their home. Edgewater tendered the claim to itsinsurers, plaintiff State Farm Fire & CasualtyCompany and defendant American Family MutualInsurance Company. State Farm accepted thetender, but American Family did not.Thereafter, State Farm brought a declaratoryjudgment action against American Family seeking adeclaration that American Family was obligated todefend Edgewater and contribute to the cost ofdefense incurred by State Farm. The trial courtruled in State Farm’s favor, concluding that theclaim alleged a time period covered by AmericanFamily’s policy, an occurrence as defined by thepolicy, and damages covered by the policy.American Family appealed and the Court ofAppeals reversed. On appeal, American Familyasserted that the allegations of the complaint failedto allege property damage within the terms of thepolicy because the allegations did not specifyresulting damage beyond damage to the work itself.The court focused on whether the homeowners’complaint against Edgewater, without amendment,would allow them to offer evidence and recoverdamages for injury to property other than the EIFScladding itself.To answer the question, the court analyzedthe pleading rules under ORCP 18 B.Compensatory damages for injury to real propertyare divided into categories of general and special (orcollateral) damages. General damages naturally andnecessarily result from the injury alleged, whereasspecial damages may flow naturally from the injury,but not necessarily. General damages are notrequired to be pled with specificity, but specialdamages are. If the exact nature of special damagesis not pled with specificity, the court will excludeevidence of them and preclude recovery on them.Upon review of the homeowners’complaint, the court concluded that none of theallegations of property damage extended beyondEIFS cladding itself. It further concluded that,although water damage to other buildingcomponents may naturally result from defects in theEIFS cladding, water intrusion was not a “necessaryresult” of the defect. Because the homeownersfailed to specifically plead resulting losses asspecial damages, their complaint did not triggercoverage for resulting property damage underAmerican Family’s policy.
  • 17. ________________________________________Construction Law Newsletter Issue 41. Page 179. INSURANCE/SUBROGATION:INSURER WHO PAID UNDER POLICY ISNOT ENTITLED TO RECOVER AGAINSTOTHER INSURERS UNDER THEORIES OFCONTRIBUTION, INDEMNITY, ANDSUBROGATION WHEN THE OTHERINSURERS WERE NOT LIABLE AT THETIME THE INSURER MADE PAYMENTBECAUSE OF LIMITATION PERIODS INTHE OTHER INSURERS’ POLICIES.Fireman’s Fund Insurance Company v. UnitedStates Fidelity and Guaranty Company, No. CV-09-263-HU, 2010 WL 1959148 (D Or May 17,2010).The Fireman’s Fund Insurance Companyinsured a building under a policy period beginningJuly 1, 2000. The owner of the buildingdiscovered water damage that had been occurringsince construction of the building in 1998.Fireman’s Fund eventually paid under its policyand brought an action against other insurers whohad insured the property after construction andbefore the Fireman’s Fund’s policy went intoeffect. Fireman’s Fund asserted claims forequitable contribution, common law indemnity,and equitable subrogation. The other insurersmoved for summary judgment, which the courtgranted.All of the other insurers’ policies hadlanguage that included a limitations period thatrequired all actions for property damage under therespective policies to be brought within two yearsfrom the date of the damage. Moreover, theapplicable policy language did not include adiscovery rule. Accordingly, under the languageof the contracts, the prior insurers could not havebeen liable under the policies for a claim that wasbrought before June 30, 2002, two years from theexpiration of the latest policy period. In this case,however, the insured did not assert a claim until2003. Because under the law of subrogation,Fireman’s Fund was subject to all of the policydefenses that would be valid against the owner, thelimitations defense was valid against Fireman’sFund.The analysis under the indemnity andcontribution theories turned on the same facts.Because of the policy limitations period, the otherinsurers owed no legal obligation to pay the policywhen Fireman’s Fund made payment in 2005.Although both indemnity and contribution claimshave their own separate statute of limitationsperiod, a plaintiff cannot recover unless itdischarged a duty owed by the party from whom itseeks indemnity or contribution. Claims forindemnity and contribution cannot revive theunderlying statute of limitations when it ran beforethe insurer made the payment for which it is seekingcontribution and indemnity.10. NEGLIGENCE: A PLAINTIFF MAYPURSUE A CLAIM FOR NEGLIGENTCONSTRUCTION NOTWITHSTANDING ACONTRACTUAL RELATIONSHIP WITHTHE BUILDER IF THE PLAINTIFFALLEGES THAT THE BUILDERUNREASONABLY CAUSED FORESEEABLEPROPERTY DAMAGE AND THECONTRACT DOES NOT ELIMINATE THECONTRACTOR’S LIABILITY FORCOMMON LAW NEGLIGENCE. IN SUCHCASES, THE STATUTE OF LIMITATIONSON THE NEGLIGENCE CLAIM IS TWOYEARS FROM DISCOVERY OF THEDAMAGE.Abraham v. T. Henry Construction, Inc., 350 Or 29,249 P3d 534 (2011), recons. denied (May 5, 2011).Plaintiffs hired defendants to build a home,which was substantially completed in 1998. Morethan six years later, plaintiffs discovered waterdamage and brought claims against defendants forbreach of contract and negligent construction. Thenegligent construction claim was based on threetheories: common law negligence, violation of aduty created by a special relationship, andnegligence per se based upon violation of theOregon Building Code.Defendants moved for summary judgmentagainst the contract claim because it was notbrought before the six-year statute of limitationshad expired, and against the negligence claimbecause plaintiffs and defendants did not stand in a
  • 18. ________________________________________Construction Law Newsletter Issue 41. Page 18special relationship to each other. The trial courtentered judgment in favor of defendants on bothclaims. With respect to the negligence claim, thetrial court held that under Jones v. Emerald PacificHomes, Inc., 188 Or App 471 (2003), a homeownerwho contracts with a builder cannot assert anegligence claim absent a special relationship withthe contractor, and there is no special relationshipbetween a homeowner and a contractor.The Court of Appeals affirmed the decisionon the contract claim, but reversed on thenegligence claim. First, the Court of Appeals heldthat when a construction contract merelyincorporates a general obligation of reasonable care,Jones correctly requires that the plaintiff must showa standard of care independent of the contractarising from a special relationship, statute, oradministrative rule. Plaintiffs’ arms-length contractwith defendants to build the home, however, did notcreate the type of special relationship that couldsupport the negligence claim. But the Court ofAppeals also held that the Oregon Building Codecreated a standard of care independent of thecontract, thus plaintiffs’ allegations that theirdamage arose from defendants’ violations of theBuilding Code supported a negligence claim.Defendants appealed and the SupremeCourt affirmed, though on different grounds. TheSupreme Court first noted that tort liability based oncommon law duty to avoid foreseeable injury toothers exists whether or not the parties are incontract, unless the contract modifies or eliminatesthe common law duty. Parties do not waivecommon law tort rights merely by entering into acontract.The Supreme Court then rejecteddefendants’ argument that, under GeorgetownRealty v. The Home Ins. Co.¸ 313 Or 97 (1992), aparty to a contract could only bring a tort claimarising out of a breach of contract if a specialrelationship existed that created an independentstandard of care. The Supreme Court distinguishedGeorgetown because it was a case in which a partyseeking economic loss had to stand in a specialrelationship to recover for negligently-causedeconomic harm, whereas plaintiffs’ harm in thiscase involved property damage.Finally, without mentioning Jones, theSupreme Court held that the parties did not modifyor eliminate the common law duty to avoidforeseeable injury simply by including in thecontract language that the contractor must completeits work in a workmanlike manner and comply withbuilding codes. Such a contractual promise existswhether or not it was included in the contract, so abreach of the promise could give rise to bothcontract and tort liability. Because plaintiffs hadalleged that defendants unreasonably causedforeseeable property damage and the parties’contract did not eliminate defendants’ common lawduties, plaintiffs were entitled to proceed on thenegligence claim.Although not asked to determine thelimitations period for a claim arising out of propertydamage caused by negligent construction, theSupreme Court included in a footnote that theapplicable statute was ORS 12.110. Under ORS12.110, tort claims must be brought within twoyears from the date they accrue, which the courtsaid was normally upon discovery, limited only bythe statute of repose in ORS 12.135.Because the court was not asked to decidethis issue, plaintiffs moved for reconsideration. Inparticular, plaintiffs asserted that the footnote couldforeclose application of the six-year limitationsperiod under ORS 12.080(3) (injury to an interest ofanother in real property) for claims of negligentconstruction. The Supreme Court, however,refused to modify its opinion.11. PRESERVATION OF ERROR: THEPLAIN ERROR EXCEPTION TO ORCP 59 HIS NARROWLY CONSTRUED.State v. Guardipee, 239 Or App 44, 243 P3d 149(2010).Counsel for defendant in this criminal caseproposed a jury instruction to which the Stateobjected. The court accepted the State’s positionand refused to give the jury instruction. Defensecounsel failed to raise the objection again after thejury was instructed as required by ORCP 59 H(1).
  • 19. ________________________________________Construction Law Newsletter Issue 41. Page 19On appeal, the defendant asserted that the courtcould still review the failure to give theinstruction, notwithstanding the failure to complywith ORCP 59 H, because of the court’s ability toreview a plain error on the face of the record. Thecourt rejected defendant’s argument, holding thatonly in narrow and rare circumstances would thecourt circumvent the broad conclusive effect ofORCP 59 H. The case at hand did not present thefacts to which deviation from the rule would bewarranted.12. PRESERVATION OF ERROR:OBJECTIONS TO JURY INSTRUCTIONSUNDER ORCP 59 H MUST BESUFFICIENTLY SPECIFIC TO ALLOWTRIAL COURT TO CORRECT ALLEGEDERROR.Hammer v. Fred Meyer Stores, Inc., 242 Or App185, 255 P3d 598, rev. den., 350 Or 716 (2011).Plaintiff was injured in defendant’s storewhen removing product from an end-cap display.Before the case was sent to the jury, plaintiff askedthat the jury be given a res ipsa loquiturinstruction. Defendant objected, contending thatthe instruction was not warranted by the evidence,that the instruction failed to address the element ofexclusive control, and that the instructionimproperly burdened the defendant to prove theabsence of its own negligence. The court gave theinstruction anyway, after which defendantobjected, again restating that the evidence did notsupport the res ipsa loquitur instruction andasserting that the case should have gone to the juryon a regular negligence instruction.The Court of Appeals held that defendantfailed to properly preserve any error with respectto the jury instructions. Defendant’s post-juryinstruction objection was not sufficientlyparticular to allow the trial court an opportunity tocorrect the error. Based on its review of therecord, the Court of Appeals held that nothing indefendant’s objections before or after the giving ofthe res ipsa loquitur instruction informed thejudge how the instruction failed to address anessential element of the doctrine or otherwise wasinaccurate. Generally arguing that the instructionshould not be given was not enough. Accordingly,the court did not consider the merits of whetherthe instruction was proper.13. WAGE AND HOUR: A GENERALCONTRACTOR IS NOT THE “EMPLOYER”OF ITS SUB-SUBCONTRACTOR’SEMPLOYEES UNDER APPLICABLE WAGEAND HOUR LAWS, WHEN THEEMPLOYEES PERFORM FRAMING WORKON ONLY ONE OF THE GENERALCONTRACTOR’S PROJECTS.Gonzales v. Sterling Builders, Inc., No. 08-CV-943-BR, 2010 WL 1875620 (D Or, May 6, 2010).General contractor LC Construction andRemodeling, Inc., contracted with SterlingBuilders, Inc., to provide framers for aconstruction project. Sterling Builders, in turn,subcontracted with Hammer Construction, LLC, toprovide the framers to perform the work on theproject. Although LC Construction paid SterlingBuilders all periodic payments due under thecontract, the framers walked off the projectasserting they had not been paid. Later, several ofthe framers initiated claims under the Fair LaborStandards Act (“FLSA”) and Oregon’s wage andhour laws.The court granted summary judgment infavor of LC Construction because plaintiffs failedto establish that they were employees under themulti-factored tests to determine employee statusunder the FLSA. Gonzales provides thepractitioner a detailed framework for how a courtcould approach all the factors in a wage and hourcase. With respect to issues that may beapplicable in a broad number of cases, the courtheld that a general contractor’s authority to set theoverall schedule for a construction project did notequate to having the authority to supervise andcontrol a particular subcontractor’s employee’swork conditions.The court also held that, because this wasthe only LC Construction project that the plaintiffshad worked on, plaintiffs could not show that theywere the equivalent of LC Construction employeesbased on being moved from work site to work site.
  • 20. ________________________________________Construction Law Newsletter Issue 41. Page 20Because the application of the Oregon wage andhour laws tracks the FLSA, the court grantedsummary judgment on the Oregon wage and hourlaw claims for the same reasons.14. WAGE AND HOUR: ACONTRACTOR MAY BE AN “EMPLOYER”OF THE DRYWALL SUBCONTRACTOR’SEMPLOYEES WHEN THE CONTRACTOREXERTED A CERTAIN DEGREE OFCONTROL OVER THE LABORERS ANDUSED THE SAME LABOR CREWS ONSEVERAL PROJECTS.Chao v. Westside Drywall, Inc., 709 F Supp 2d1037 (D Or 2010).The United States Department of Labor(“DOL”) brought a claim against WestsideDrywall, Inc., on behalf of more than 50 laborersunder the Fair Labor Standards Act (“FLSA”).The DOL claimed that Westside had improperlyemployed drywall laborers through subcontractrelationships in an effort to avoid the requirementsof the FLSA minimum wage and overtime rules.Westside filed several motions for summaryjudgment against the claims related to variousworkers or classes of workers. In general, thecourt denied the motions because Westside wasthe employer of the laborers.As with most wage and hour cases, thecourt’s analysis of whether the particular workerswere “employees” of Westside was a heavily fact-dependent analysis. With respect to issues thatmay be applicable in a broad number of cases, thecourt held that the following supported theconclusion that the workers were employees:Westside specifically determined the project sitesto which the work crews were assigned, decidedwhat materials were to be used on each project,and required the laborers to track time and providethe time sheets to Westside for payment.Westside’s supervisors also regularly visited thejob sites and “supervised” the workers. Moreover,some of the workers were paid on an hourly basiswith no opportunity for commission or bonus asopposed to a true subcontractor relationship inwhich the workers could realize a greater benefitthrough efficiencies of work. Finally, the workerstended to work exclusively on Westside projectsduring the relevant time frame.Chao also provides a good reminder aboutadhering to evidence rules when submittingdeclarations in support of summary judgment.For example, both parties had submitteddeposition transcripts that did not include areporter’s certification so the court refused toconsider them when making its ruling. Otherdeclarations were submitted without recitation thatthey were made under the penalty of perjury, sothey too were disregarded.“CLASS OF ONE” STATUS ANDDEVELOPMENT PERMITSScot SiderasClackamas County CounselThe Ninth Circuit Court of Appealsrecently issued a decision that is of particularimport to projects burdened by a failure to receivepermits or an idiosyncratic approach to grantingpermits. Gerhart v. Lake County Montana, 637F.3d 1013, 2010 U.S. App. LEXIS 27112 (USSupreme Court certiorari denied by Gerhart v.Lake County, 2011 U.S. LEXIS 5784 (U.S., Oct. 3,2011).Plaintiff Allan Gerhart was a propertyowner and resident of Lake County, Montana. In2007, he found the easement from his neighborswas no longer useful as a means to access hisproperty, so he built his own access road andapproach from his house to Juniper Shores Lane, acounty road that borders his property. As he wascompleting his approach, Gerhart was informed bya County employee that the County requirespermits for road approaches.Gerhart filed an approach permitapplication, and originally was told by the sameCounty employee, who was the RoadSuperintendent of the County, that his approachlooked good. That employee signed off on
  • 21. ________________________________________Construction Law Newsletter Issue 41. Page 21Gerhart’s permit, and forwarded it to the threeCounty Commissioners, which was the usualprocedure. What was not usual is that the RoadSuperintendent was later told that Gerhart’s permitapplication was to be “put on hold” by theCommissioners, and several months later Gerhartwas sent a letter which informed him his permitwas denied, without explanation.Mr. Gerhart learned that most of hisneighbors had created their own approaches toJuniper Shores Lane, though none of them hadapplied for a permit. When Gerhart received hisdenial letter, his attorney sent a letter to theCommissioners noting that all the other neighborsdid not get permits. In response, Gerhart was senta letter from the Commissioners, stating for thefirst time several reasons for denying hisapplication, suggesting he had an alternativeaccess to his property, and citing safety concerns.When the parties were not able to resolvethe dispute, Gerhart filed a suit under 42 U.S.C.Sec. 1983, alleging the County and individualCommissioners violated his due process and equalprotection rights.The district court granted summaryjudgment to the Defendants after concludingGerhart could not establish a constitutionalviolation. On appeal, the summary judgment wasaffirmed as to the County and the individualCommissioners on Gerhart’s due process claims,but the court reversed the grant of summaryjudgment to the individual Commissioners onGerhart’s equal protection claim, and the case wasremanded for trial.The Due Process Claim: To succeed oneither a procedural or substantive due processviolation claim, Gerhart needed to show he wasdeprived of a constitutionally protected propertyinterest. While it is possible to have a propertyinterest in a government benefit, the claimant mustbe able to show a legitimate claim of entitlement.Gerhart’s due process claim failed because thepermit process allowed for government discretionin the decision making process.Because discretion was not limited byMontana law, Gerhart had no entitlement to anapproved permit simply because he filed thecorrect paperwork. The fact that Gerhart thoughthe was approved based on the County employee’srepresentations, or the fact the Commissioners hadgenerally been lenient in other landowners’ casesdid not give Gerhart an entitlement to an approvedpermit. Gerhart therefore did not have a protectedproperty interest in an approach permit, and so didnot have a due process violation.The Equal Protection claim: TheSupreme Court has recognized that “an equalprotection claim can in some circumstances besustained even if the plaintiff has not alleged class-based discrimination, but instead claims that shehas been irrationally singled out as a so-called‘class of one.’” Village of Willowbrook v. Olech,528 U.S. 562,564 (2000). To succeed on his “classof one” claim, Gerhart must demonstrate that theCommissioners: (1) intentionally (2) treatedGerhart differently than other similarly situatedproperty owners and (3) without a rational basis.The Court found that the facts in this casemake it very arguable that the Commissionersintended to treat Gerhart differently from otherpetitioners. The Court of Appeals found that therecord showed there were triable issues of fact onthis prong of the test. Similarly, the Court waspersuaded that facts exist in the record to supportGerhart’s claim that he was treated differently thanother permit applicants. Finally, the record alsosupports a conclusion that there is a genuine issueof material fact as to whether the Commissionershad a rational basis for treating Gerhart differentlyfrom similarly situated property owners.Because the court found there weregenuine triable issues of fact as to the merits ofGerhart’s equal protection claim, it was not properto grant the Commissioners a summary judgment.As noted above, the case was therefore remandedfor trial to evaluate the equal protection violationclaim.
  • 22. ________________________________________Construction Law Newsletter Issue 41. Page 22Construction Law SectionExecutive CommitteeDarien Loiselle, chair: dloiselle@schwabe.comJames Van Dyke, chair-elect:jvd@ci.portland.or.usGary Christensen, past chair:gary.christensen@millernash.comPete Viteznik, Secretary:pviteznik@kilmerlaw.comJason Alexander, Treasurer:jason@sussmanshank.comMembers at Large:Fritz Batson: batson@gleaveslaw.comBill Boyd: william.j.boyd@state.or.usTimothy Dolan:timothymdolan@oregoncoast.comDan Duyck: dduyck@whippleduyck.comFrank Elsasser: frankelsasser@comcast.netDan Gragg: gragg@seifer-yeats.comTara Mellom: tmm@scott-hookland.comBob O’Halloran: roberto@mcewengisvold.comTom Ped: tped@williamskastner.comScot Sideras: scotsid@co.clackamas.or.usTyler Storti: tstorti@lawssg.comJeremy Vermilyea; jvermilyea@schwabe.comNewsletter Editor:Alan Mitchell: alan@mitchell-lawoffice.comNOTE: Prior newsletters are available (in asearchable format) at the Section’s website:www.osbarconstruction.com.