Construction Law Blog

This blog has frequently addressed contractual notice and claim procedures and the Mike M Johnson[i] line of decisions (for example, see blog articles from January 2, 2008, February 15, 2011, July 10, 2012).  A recent unpublished decision by the Division I Court of Appeals is noteworthy because it holds that if a contract has a mandatory procedure for resolving claims, but does not state that the failure to follow that procedure will operate as a waiver of such claim, then a forfeiture will not be found despite lack of compliance. 

Shepler Construction, Inc. v. Leonard,[ii] involves a residential construction dispute over a project performed in 2000 with an incredibly long litigation history dating back to 2002.  The decision that is the subject of this article is the Court of Appeals’ third decision in the matter!

In 2001, the Contractor (Shepler) sent the Owner (Leonard) a letter recommending that the Owner should initiate the contractual dispute resolution process with respect to the Owner's allegations of construction defects.  The Owner admittedly failed to respond and did not initiate the contractual process.  The Contractor then filed a lien and brought a foreclosure action.  In 2008, the Contractor obtained a Summary Judgment Order precluding the Owner from asserting counterclaims for construction defects on the grounds that the Owner failed to initiate binding arbitration as required by the parties' contract in order to resolve allegations of construction defects.  That order is the subject of the appellate decision that is the subject of this article. 

In dismissing the Owner's claims for construction defects, the trial court was persuaded that the Owner's breach of the agreement by failing to seek arbitration required dismissal of all of the Owner's claims for construction defects that should have been arbitrated.  The Contract clause at issue provided:

If a dispute arises between owner and contractor as to the performance of contractor's obligations under this agreement, such disputes shall be resolved as follows:

Each party shall employ a contractor of his or her choice to evaluate the work completed.  The contractors then will select a third contractor to act as an impartial arbiter.  This contractor shall, likewise, inspect the construction to determine if the work has been performed in accordance with this agreement, applicable building codes and in a good workmanlike manner as provided hereinabove.  If two of the three contractors determine that the work is not in conformity with the provisions of this agreement, then they shall state in writing the work in need of repair or replacement and contractor shall undertake to perform same as soon as reasonably practical.  Contractor shall be responsible for owner's fees and costs associated with this arbitration as well as the impartial contractor's fees and costs.  If no remedial work is recommended by the contractors, then the owner shall pay for the costs of the arbitration.  The owner shall forthwith pay the amounts due to the contractor as established by a majority of the arbiters.

The Contractor argued to the Court of Appeals that under Absher Const. Co. v. Kent School District,[iii] and Mike M. Johnson v. County of Spokane, that the Owner's admitted failure to arbitrate its construction defect claims operated as a waiver of those claims.  Division One, however, disagreed, on the grounds that unlike the contract language at issue in Absher and Mike M. Johnson, the contract between the Contractor and Owner did not explicitly provide that the failure to follow dispute resolution procedures constituted a waiver of claims.  Division One ruled:

Shepler relies on Absher and Mike M. Johnson, Inc. v. Spokane County.  This reliance is misplaced.  Absher and Mike M. Johnson are distinguishable from the contract at issue here, because the contracts in those cases explicitly provided that failure to follow dispute resolution procedures constituted a waiver of those claims.

In addition, Division One held that waiver of the right to arbitrate does not mean the underlying claims are waived:

...Washington courts have long held that the contractual right to arbitration may be waived through a party's conduct if the right is not timely invoked.  The right to arbitrate is waived by conduct inconsistent with any other intention but to forego a known right.  Simply put, a party waives a right to arbitrate if it elects to litigate instead of arbitrate.  The [Owners] filed their counterclaims in 2002.  [The Contractor] did not assert arbitration as a defense or move to dismiss the [Owner’s] arbitrable claims on that basis until 2008.  Both parties waived the dispute resolution clause by conduct. 

Comment: This unpublished case provides guidance that the failure to comply with a contractual claim procedure may not give rise to forfeiture of the underlying claim if the contract clause at issue does not include language stating that the failure to comply will operate as a waiver of the claim.  In addition, the decision reinforces that a mandatory contract provision can be waived by the party it benefits, which is another basis to defeat an argument that the failure to comply results in forfeiture.

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[i] 150 Wn.2d 375, 78 P.3d 161 (2003).

[ii] Shepler Construction, Inc., v. Leonard, 68227-0-I (unpublished 2013).

[iii] 79 Wn. App. 841, 917 P.2d 1086 (1996).

Exterior Insulation Finish Systems, commonly known as EIFS or synthetic stucco, are multi-layered exterior wall systems used on both commercial buildings and residential homes. These systems, as illustrated below, are usually comprised of five layers: (1) an exterior finish; (2) a reinforcing mesh to protect the system; (3) an insulator (i.e. Expanded polystyrene (EPS) foam); (4) an adhesive substance binding the insulator to the building; and, (5) a substrate to which the insulator is attached. 

When EIFS was introduced nearly 30 years ago, commercial and residential property owners and developers were attracted to the stucco-like appearance that allows broad design and color flexibility at low costs.  The benefits of low maintenance and durability and increased energy efficiency also added to its initial popularity.  However, problems began to arise overtime where the systems were not installed, caulked, or sealed properly.  Rainwater, wind-driven rain, or moisture was commonly penetrating poor quality window and door openings.  This causes water to be trapped behind the EIFS exterior.  The waterproof design of EIFS that was supposed to keep water out actually prevented water from leaving the system.  With nowhere to go, the water begins soaking into wall studs and plywood sheathing, which in most cases lead to rot. 

Insurers issuing general liability policies to construction contractors caught on to the rot problem quickly and began drafting exclusions in their policies.  Exclusions for construction defect claims involving EIFS are now common and vary in breadth from excluding coverage for any work performed on EIFS to any property damage arising out of or caused by EIFS.  Naturally, this caused many contractors to stop installing EIFS or parts that interfaced with the system.    

A recent decision by the U.S. District Court of Washington (at Seattle) should give further pause to those contractors that do any work on any exterior component, fixture, or feature of a structure where EIFS is used on any part of the building or home.  In First Mercury Insurance Company v. Miller Roofing Enterprises,[i] a roofing contractor installed a roof in 1998 on a building with a home decorating showroom.  In 2006, the roofing contractor returned twice to perform repairs pursuant to two oral agreements.  Despite the repairs, the roof leaked after heavy rain and snow storms in 2007.  The owner sued the roofing contractor for breach of the two oral contracts.  The insurer initially defended the roofer against the owner’s lawsuit under a reservation of rights.  Concurrently, the insurer filed a declaratory judgment action in federal court for a declaration of no coverage and filed for an immediate summary judgment based on the insurance policy’s EIFS exclusion.  The insurance policy at issue contained the following EIFS exclusion:

This insurance does not apply to ... “property damage” included in the “products-completed operations hazard” and arising out of “your work” described as ... [a]ny work or operation with respect to any exterior component, fixture or feature of any structure if any “exterior insulation and finish system” is used on any part of that structure.

The U.S. District Court of Washington granted summary judgment and held that the exclusion barred coverage.  The roofer first argued that the EIFS exclusion does not apply because the leak was the result of “defective workmanship to the roof itself,” and the roofer “did not install the EIFS on the building, nor did it undertake to make any repairs to the EIFS itself.”  The Court held this was “irrelevant” because “[t]he exclusion applies not only to property damage arising from EIFS-related work by the insured; it applies to property damage arising from ‘any’ work by the insured on an exterior component, fixture, or feature of a structure, as long as ’exterior insulation and finish systems’ is used on any part of that structure.”  The roofer argued second that EIFS was employed only on the exterior walls of the structure and not where the roofers performed repairs.  The Court held this was also irrelevant because “[t]he exclusion applies if ‘any’ exterior insulation and finish system is used on any part of th[e] structure.” 

Essentially, the Court agreed with the insurer’s reading of the exclusion: this exclusion “mean[s] that [the insurer] could escape any liability from any negligent act performed [by any contractor that works on any exterior component, fixture, or feature] on the building because [EIFS] was placed over the exterior walls.”  As a result of the judgment, the roofer faces paying for all the cost of its defense against the underlying lawsuit moving forward and any damages awarded to the owner out of its own pocket.   

Comment: We advise those contractors working on any exterior component, fixture, or feature of a building or residence that uses or will use any EIFS to review your insurance policy for any EIFS exclusions similar to the one above.  An endorsement to your policy or a separate policy may need to be procured to cover your work.

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[i] (2013 WL 662970).

In 2007, C 1031 Properties, Inc. ("C 1031"), a Spokane developer, purchased a former drive-in movie theater site for construction of a self-storage facility.[i]  The purchase and sale agreement required the developer to inspect the property, and the developer's agent signed an acknowledgement that he had sufficient time to inspect the property and approve the boundary line location and physical conditions of the property, which included power lines and power poles on the property.  C 1031's title insurance company, First American Title Insurance Company ("First American"), then issued a Preliminary Commitment of Title Insurance to C 1031 which required C 1031 to notify First American of any existing encumbrances on the property.  C 1031, however, failed to inform First American about the existing power poles and lines on the property.

Prior to closing the sale, C 1031's engineers prepared a full set of plans for the self-storage facility, including a survey.  Both the inspection and the survey revealed the presence of the power poles and lines at the site.  The Preliminary Commitment for Title Insurance, however, did not disclose any easement on the property.  C 1031 proceeded with closing and purchased the property.

After closing, C 1031 contacted the power company to remove the power lines and poles, but the power company refused, relying on a 1949 recorded easement granting the power company the right to maintain the electrical lines.  C 1031’s title insurance policy from First American provided coverage for "easements of record," but specifically excluded "easements ...which are not shown by the public record." 

C 1031 then sued First American for breach of title insurance coverage.  First American admitted that it failed to disclose the recorded easement, but denied coverage based on the "actual knowledge" exclusions in the policy because, it argued that C 1031 had actual knowledge based on the presence of power lines and poles on the property.  At summary judgment, the trial court ruled that the issue of actual knowledge was a matter for the trier of fact that should be determined at trial rather than a question of law to be interpreted at summary judgment.  The parties then both requested discretionary review to Division Three of the Washington Court of Appeals.

On appeal, Division Three noted that the purpose of the title insurer is to insure title and that an insured (C 1031) relies on the title insurer (First American) to discover any encumbrances recorded in the public record because it is the insurer's expert service to uncover defects in title.  First American admitted that it missed the electrical easement that was recorded on the property and that C 1031's title policy stated that "easements of record are covered."  First American argued that the policy was not violated because C 1031 had actual knowledge of the easement because it saw the power poles and lines on the property.  C 1031 argued that it had no actual knowledge of the easement, but only knowledge that the power poles and lines were located on the property.  The question before the Court of Appeals was whether the title insurance policy's "knowledge" exception applied to its coverage for easements of record.

The Court held that "the [title insurance] policy definition unambiguously defines knowledge as ‘actual knowledge’ of an easement, not ‘constructive knowledge or notice that may be imputed to’ C 1031 constructively."  And that when C 1031 "saw the power lines on the property, it acquired at best inquiry notice, not actual knowledge of a recorded easement."  (emphasis added).  Accordingly, the Court reversed and remanded to the trial court because even if C 1031 had knowledge of the power poles and lines on the property, the title insurance policy required actual knowledge of an easement in order for the knowledge exception to the title insurance policy to apply.

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[i] C 1031 Properties, Inc. v. First American Title Insurance Company,  __ Wn. App. ___, 2013 WL 2255873 (May 23, 2013).

This blog is a follow-up to an article from November 20, 2012, which discussed the likely impact on employers' drug-free workplace policies after Washington voters approved Initiative 502 which decriminalized marijuana use under state law. 

Although medical and recreational marijuana use may be legal in Colorado (and Washington), the Colorado Court of Appeals recently held that employers can fire employees who test positive for marijuana even if the employee was not using marijuana at work, and was not impaired while at work.[i]

The Colorado case involved a quadriplegic Dish Network telephone operator, who was involved in a car accident as a teenager that left him paralyzed.  He had been a medical marijuana patient since 2009, and Dish Network fired him after he failed a drug test for marijuana.  The employee sued Dish Network to get his job back because he had a valid medical marijuana license, but the trial court dismissed his case because the judge agreed with Dish Network that medical marijuana use was not a "lawful activity" covered by a Colorado state law that protected employees from being fired for legal behavior outside of the workplace.

The employee appealed the trial court's ruling to the Colorado Court of Appeals, and the appellate court affirmed the trial court.  The Court of Appeals began its opinion by providing that marijuana use is illegal under federal law, and that the only question before it was whether marijuana use was considered a "lawful activity" under federal and state law.  The Colorado "lawful activity" statute provides:

It shall be a discriminatory or unfair employment practice for an employer to terminate the employment of any employee due to that employee's engaging in any lawful activity off the premises of the employer during nonworking hours…

C.R.S. 24-34-402.5(1).  The statute did not define "lawful" or "lawful activity" so the court looked to the plain meaning of those words and determined that "lawful" meant activities "permitted by law."[ii]  Thus, the court reasoned that an activity was lawful only if it was permitted by both state and federal law.  Marijuana use is still illegal under federal law, therefore, the court held that medical marijuana use was not a "lawful activity."

The court also noted that the Colorado legislature could have fashioned the lawful activity statute to only apply to state laws, but that it did not and there was no indication that the legislature intended to prohibit Colorado employers from firing their employees when the employees engage in off-the-job activities that are illegal under federal law based on the legislative history, and other statutes that limited their applicability to state laws.

Comment: This case is similar to a case from Washington that held employers are not required to permit illegal activity in the workplace where an employee was fired after failing a drug test for marijuana even though the employee had a medical marijuana license.[iii] Based on these cases, employers are able to enforce their drug-free workplace policies prohibiting marijuana use (and other illegal substances) despite the fact that voters have decriminalized marijuana use in both Colorado and Washington because marijuana remains illegal under federal law.

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[i] Coats v. Dish Network, LLC,  2013 WL 1767846, __ P.3d __ (April 25, 2013).

[ii] Id.

[iii] Roe v. Teletech Customer Care Mgmt., 171 Wn.2d 736, 257 P.3d 586 (2011).

The Washington State Department of Transportation ("WSDOT") recently awarded an emergency contract to clean up debris and repair the I-5 Skagit River Bridge.  The bridge trusses were struck by an oversized truck and a section of the bridge collapsed into the river on May 23, 2013, just one day before Memorial Day weekend.[i][ii]

Two vehicles that were traveling on the bridge fell into the Skagit River after the oversized truck hit the truss, and large sections of the bridge also fell into the river.

On May 24, 2013, Governor Jay Inslee issued a proclamation that the estimated cost to repair the bridge is $15 million, and that emergency procurement procedures to hire a contractor were necessary to repair the bridge.[iii]  In emergencies such as this bridge collapse, RCW 47.28.170 allows WSDOT to obtain bids for the work without publishing a call for bids, and the secretary of transportation then awards the contract to the lowest responsible bidder.  In this case, WSDOT awarded the emergency contract to repair the bridge to Atkinson Construction Company ("Atkinson"), which is one of three WSDOT pre-approved emergency contractors.  Atkinson started work on the project by removing the vehicles and debris from the river.

On May 26, 2013, the Governor announced a plan to install a temporary bridge by mid-June 2013, and a permanent bridge by mid-September 2013.  Parts for the temporary bridge are already arriving on the job site and the temporary bridge, once constructed, will attempt to carry the nearly 71,000 cars that typically crossed the bridge on a daily basis.

(Computer illustration of temporary bridge structure)

The replacement bridge will eventually be constructed adjacent to the collapsed bridge.  It is unclear if the Governor's $15 million estimate included the cost to construct the new bridge, and it is also unclear whether the contract for the new bridge will be issued under the emergency procurement methods or under standard procurement methods.  It will be interesting to see how long the temporary bridge actually takes to complete, especially with the Governor's challenge to install a working temporary bridge by the middle of June.  In the meantime, traffic has been detoured through the towns of Burlington and Mount Vernon.

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[i] http://www.wsdot.wa.gov/Projects/I5/SkagitRiverBridgeReplacement/

[ii] More photos are available at the WSDOT I-5, Skagit River Bridge Flickr website (http://www.flickr.com/photos/wsdot/sets/72157633665218854/with/8808153761/)

[iii] http://governor.wa.gov/office/proclamations/13-04.pdf

A few weeks ago, we published a blog article on bid protests related to Disadvantaged Business Enterprises ("DBE") compliance matters. (DBE Bid Protests: One Contractor's Loss is Another's Gain).  A recent Court of Federal Claims case, Miles Construction, LLC, v. United States, highlights the potential issues certified entities and prime contractors can face in determining what constitutes a responsive bid and, more importantly, acknowledges that common sense must still be applied to business inclusion programs such as the DBE program. 

In 2012, Miles Construction, LLC ("Miles"), a certified Service-Disabled Veteran-Owned Small Business ("SDVOSB"), was the apparent low responsive and responsible bidder for a solicitation set aside for SDVOSBs.  The second-low bidder, however, protested the potential award to Miles contending that Miles did not meet the status requirements of a SDVOSB concern and, therefore, was ineligible for award of the project.  Specifically, in its protest letter, the second low-bidder asserted that it believed Miles and a non-SDVOSB had common ownership and control of the LLC, and because Miles is required to own 51% of the ownership interests of the LLC under the SDVOSB regulations, Miles was ineligible for SDVSOB status. 

After receiving the protest, the Department of Veterans Affairs ("VA") forwarded the protest to the VA's Office of Small and Disadvantaged Business Utilization ("OSDBU").  In turn, OSDBU requested Miles, within one week, respond to the allegations.  Miles timely responded to the protester's allegations and included supporting documentation.  Nevertheless, OSDBU advised Miles that it had concluded that Mr. Slizogski, the disabled-veteran owner of Miles, did not possess unconditional ownership of the company as required by the SDVSOB regulations because provisions of the company's Operating Agreement allegedly contained restrictions on the transfer of his ownership interest.  The shareholder agreement granted the service-disabled veteran's partner a first right of refusal if the majority owner's shares were sold.  OSDBU stated that because Miles could not demonstrate "unconditional ownership," Miles was ineligible for not only award of the contract but OSDBU also revoked Miles' SDVOSB status, preventing Miles from obtaining any future SDVOSB work.   Miles appealed to the Court of Federal Claims, alleging that OSDBU's decision was arbitrary and capricious and contrary to law, and Miles sought reinstatement of the contract award. 

On February 7, 2013, the Court of Claims issued an order setting aside OSDBU's decision and reinstating Miles status as a SDVSOB.  The court concluded that the VA's interpretation of its own eligibility regulations was arbitrary and capricious.  Specifically, although the regulations require that the veteran-owner possesses "unconditional ownership" of the company, the requirement does not preclude standard terms that deal with future events which may or may not impact the veteran's ownership: 

In sum, the right of first refusal provision in Article XI is not presently executory, is a standard provision used in normal commercial dealings, and does not burden the veteran's ownership interest unless he or she chooses to sell some of his or her stake.   As a result, [the right of first refusal provision] does not affect the veteran's unconditional ownership with regard to the SDVOSB regulations.  The decision by OSDBU to the contrary...was arbitrary and capricious and contrary to law. 

For example, the provision will not hinder the veteran-owner's interest unless the veteran receives a bona fide offer and chooses to sell.  In addition, upon a sale, the company does not automatically retain its eligibility for the SDVSOB status because it might no longer be owned by a veteran who meets all the eligibility requirements.  

In addition, the Court also criticized the OSDBU's failure to provide Miles with an adequate opportunity to respond to the allegations (i.e., due process).  The Court found that the OSDBU's expansion of the protest to encompass Miles' general compliance with the SDVOSB regulations (which was not raised by the protester-the protester only made contentions that Mr. Slizofski's ownership interest was a façade and that another company actually controls Miles) was "plainly erroneous" and "cannot be upheld."  The Court stated that "[a]n agency should not act without affording the entity whose award or projected award is protested with notice of an alleged defect and an opportunity to respond." 

The decision is silent as to the Court's reasoning to issue an injunction directing award of the contract to Miles, but nevertheless, this opinion should be viewed as a triumph for small certified firms.  As this office has reported, programs designed to promote minority and typically underrepresented groups, including the SDVOSB program, the federal Disadvantaged Business Enterprise program, and the state Minority and Woman-owned Business program, have come under recent media scrutiny aimed at individuals allegedly defrauding the programs.  For example, common fraud accusations include allegations that the disadvantaged owner does not meet the economic disadvantage requirement (e.g., a personal net worth less than $1.32 million) or that the eligible person is simply a proxy for a non-disadvantaged individual.  This media scrutiny has regrettably resulted in an "overcorrection" as the agencies that administer these programs seek to "clean up the purported fraud," forcing properly certified firms to repeatedly (and at great expense) defend their certification status.  This case is a clear example of such agency overcorrection.  Rather than acknowledge that these small, disadvantaged firms still adhere to typical commercial practices such as the right of first refusal provision (that may allow other owners some say in how their ownership interest is treated or their company's future), certification agencies or unsuccessful bidders attempt to exploit such technicalities to improperly decertify firms or preclude those firms from obtaining work.  Thus, these minority and disadvantaged entity programs and the agencies which administer the programs end up penalizing and attacking the very businesses the programs are designed to promote. 

Although this case is a small step towards reigning in such overcorrection, it is also a reminder of just how strictly the agencies interpret the complicated and detailed certification regulations, often to the detriment of firms the programs were created to foster, and to the taxpaying public that pays the price for the endless protests.   While this case will hopefully have an impact on the DBE program, it is critical that firms attempting to apply for certification review their corporate documents closely to ensure that they will not unknowingly be tripped up by such technicalities. 

Thank you to the Federal Construction Contracting Blog for first reporting on the case (2/19/13).  The firm that authors the Blog, Cohen Seglias Pallas Greenhall & Furman PC, successfully represented Miles Construction, Inc. before the Court of Federal Claims.

In the Pacific Northwest, most public works construction is performed by union contractors.  Often times the contract will include a Project Labor Agreement ("PLA") mandating that all workers on the site are subject to the terms of the union agreement.  Labor relations in the U.S. are generally subject to federal regulation, particularly if the project is federally funded.  Most large public works projects have some amount of federal money in them, and therefore, are subject to federal law.  The National Labor Relations Act ("NLRA") is a federal law which protects an employee's right to engage in "concerted activities for mutual aid and protection." The most common of these "concerted activities" is collective bargaining.

PLAs are pre-hire agreements establishing terms and conditions of employment for the project, which are negotiated between an owner and unions, and are common form of collective bargaining agreement in the construction industry. A PLA requires all contractors, whether they are unionized or not, to subject themselves and their employees to the terms of the collective bargaining agreement (the union contract) as a condition of performing work on a construction project. Union wages, no-strike clauses, grievance procedures, and mandatory arbitration of disputes are among the terms often included in PLAs.

On July 19, 2011, Michigan enacted the Michigan Fair and Open Competition in Governmental Construction Act (the "Act") aimed at limiting the use of PLAs in Michigan public construction contracts. Section 5 of the Act states:

A governmental unit shall not enter into or expend funds under a contract for the construction, repair, remodeling, or demolition of a facility if the contract or subcontract under the contract contains any of the following:

(a) A term that requires, prohibits, encourages, or discourages bidders, contractors, or subcontractors from entering into or adhering to agreements with a collective bargaining organization relating to the construction project or other related construction projects.

(b) A term that discriminates against bidders, contractors, or subcontractors based on the status as a party or nonparty to, or the willingness or refusal to enter into, an agreement with a collective bargaining organization relating to the construction project or other related construction projects.

M.C.L. § 408.875.  Additionally, Section 9 of the Act prohibits the government or any construction entity acting on behalf of the government from placing any terms described in Section 5 in bid specifications, project agreements, or other contract documents.  M.C.L. § 408.879.

In Michigan Bldg. and Const. Trades Council, AFL-CIO v. Snyder,[i] several trade associations and organized labor groups (the "Unions") filed suit claiming that Michigan's Act was preempted by the NLRA. The Unions filed a motion for summary judgment, arguing the NLRA preempted the Act because it effectively banned PLAs on all government contracts, which is a form of concerted activity protected by the NLRA. Michigan argued that the Act was not regulatory, and thus not subject to NLRA preemption.  The District Court agreed with the Unions and granted summary judgment holding the Act to be unenforceable because it was preempted by the NLRA, and that the "market participant" exception to NLRA preemption did not apply.

The NLRA Preempts Michigan's Act

Although the NLRA does not expressly preempt state law, the Supreme Court of the United States has articulated two distinct NLRA preemption principles - state and local governments are prohibited from regulating: (1) activities that are protected by Section 7 (which protects an employee's right to negotiate and secure a PLA) or constitute an unfair labor practice under the NLRA,[ii] and (2) areas that Congress intended to be left unregulated.[iii]

In this case, the District Court found that the Act violated both preemption principles.  First, the Act regulated employees' ability to negotiate and secure a PLA - activities protected by Section 7 of the NLRA.  Specifically, Section 5 of the Act prevented governmental entities from entering into PLAs, and Section 9 prohibited the state from "expending funds" if a contract or subcontract contained a PLA.  Based on these facts, the District Court held that the Act created an impermissible obstacle to employees' right to bargain on government construction projects, and therefore, the Act was preempted by the NLRA because the two laws could not "move freely within the orbits of their respective purposes without impinging upon one another."[iv]

Similarly, under the second preemption principle, the District Court found that the Act regulated areas that Congress intended to be left unregulated by the states because Congress had specifically authorized certain behaviors in the construction industry under Sections 8(e) and (f) of the NLRA.  The District Court held that Congress intended to balance the power for bargaining in the construction industry when it enacted Section 8(e), which exempts the construction industry from the general prohibition of "hot cargo" agreements (agreements between a union and employer which require the employer to boycott goods or services of another person), and Section 8(f), which authorizes pre-hire agreements that set terms and conditions of employment.  The District Court found that Congress, in enacting Section 8(e) and (f) of the NLRA, intended PLAs to be permissible in the construction industry.  Thus, the NLRA preempted the Act because it impermissibly prohibited PLAs on all government construction projects, which Congress had expressly allowed.

The Market Participant Exception Does Not Apply

Michigan argued that even if the NLRA preempted the Act, the Act was exempt because the state was acting as a "market participant" (i.e., acting in a proprietary/private function, rather than a regulatory/governmental function).  The NLRA does not preempt state laws when a state acts as a "market participant" furthering its proprietary interests, as opposed to its regulatory interests.  For example, when a state owns and manages property, it must interact with private entities (i.e., the state is a "market participant") and is not subject to preemption by the NLRA because it is acting in a proprietary function, as a private business would act.

In this case, however, the District Court rejected Michigan's argument that the Act was proprietary because it was not narrowly tailored to a specific project, but was an across the board ban on PLAs on all public works projects, and because the Act impermissibly affected private conduct unrelated to efficient procurement of goods or services (as in a private business relationship). The District Court found that the Act's "rigid, unbending policy smacks of regulation" and, therefore, was preempted by the NLRA, and that the state was not a "market participant."

Comment: Employers in the construction industry should proceed cautiously when dealing with PLAs. The NLRA forbids employers from interfering with, restraining, or coercing employees in the exercise of rights relating to organizing, or from working together to improve terms and conditions of employment. Employers may not threaten their employees with loss of jobs or benefits if they join or vote for a union advocating for PLAs, promise benefits to employees to discourage their union support, or otherwise punish employees because they participated in an investigation conducted by National Labor Relations Board.

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[i] 846 F. Supp. 2d 766 (E.D. Mich. 2012).

[ii] See San Diego Bldg. Trades Council, Millmen’s Union, Local 2020 v. Garmon, 359 U.S. 236, 79 S.Ct. 773 (1959).

[iii]See Lodge 76, Int’l Ass’n of Machinists and Aerospace Workers, AFL-CIO v. Wisconsin Empl. Relations Comm’n, 427 U.S. 132, 96 S.Ct. 2548 (1976).

[iv] 846 F. Supp. 2d at 783.

We have posted a number of blogs regarding pay-if-paid and pay-when-paid contract clauses (see A+C blogs from December 20, 2012, June 19, 2012, April 26, 2012, April 5, 2011, and March 17, 2008).

Readers of our blog likely already know that a pay-if-paid clause provides that payment by the owner to the contractor is an express condition to any payment due subcontractors or suppliers.  In contrast, a pay-when-paid clause typically provides that payment from the contractor to subcontractor or supplier must occur within a reasonable time after the contractor receives payment from the owner, regardless of whether the owner ever actually pays the contractor.  Pay-if-paid clauses shift the risk of non-payment to the subcontractor, while pay-when-paid clauses place the risk of non-payment on the contractor.

While Washington courts have not yet dealt with the pay-if-paid versus pay-when-paid distinction, some other jurisdictions have legislatively or judicially declared that pay-if-paid clauses are unenforceable as a matter of public policy.  These jurisdictions reason that a pay-if-paid clause is against public policy because, they believe, a contractor is in a better position to know the financial dealings and likelihood of payment from an owner, as compared to a subcontractor or supplier who does not deal directly with an owner.

Recent Ohio Court of Appeals' Decision

The Ohio Court of Appeals recently interpreted whether a clause in a construction contract was a "pay-if-paid" or a "pay-when-paid" provision.[i]  In that case, the parties entered into a subcontract for electrical work for a swimming pool in a hotel.  After performing the job, the subcontractor sued the general contractor for $44,088.90 for work that it completed, but did not get paid (the subcontractor had received $142,620.10 in partial payment for its work).  The general contractor filed a motion for summary judgment, asserting that the subcontract contained a "pay-if-paid" clause and, therefore, the general contractor did not have to pay because the owner had not paid the general contractor.  The subcontractor filed a cross motion for summary judgment, asserting that the subcontract's "pay-if-paid" clause was actually a "pay-when-paid" clause because the condition of payment from the owner to general contractor was not clear and explicit. 

The provision of the subcontract reads as follows:

The Contractor shall pay to the Subcontractor the amount due [for work performed] only upon the satisfaction of all four of the following conditions: (i) the Subcontractor has completed all of the Work covered by the payment in a timely and workmanlike manner, (ii) the Owner has approved the Work, (iii) the Subcontractor proves to the Contractor's sole satisfaction that the Project is free and clear from all liens, and (iv) the Contractor has received payment from the Owner for the Work performed by Subcontractor. Receipt of payment by Contractor from Owner for work performed by Subcontractor is a condition precedent to payment by Contractor to Subcontractor for that work.

(Emphasis added).  The trial court agreed with the general contractor and held that the above clause was a valid pay-if-paid clause and ruled in the general contractor's favor.  The subcontractor, however, appealed the trial court's ruling contending that the trial court incorrectly concluded that the provision was pay-if-paid because it was not clear that the subcontractor bore the risk of nonpayment.  The Ohio Court of Appeals addressed the issue by first stating that the risk of insolvency of the owner is ordinarily borne by the general contractor, and that pay-if-paid provisions are generally disfavored. 

In Ohio, to enforce a pay-if-paid clause it "must clearly and unambiguously condition payment to the subcontractor on receipt of payment from the owner."[ii]  In particular, a pay-if-paid clause must expressly state that: (1) payment to the contractor is a condition precedent to the subcontractor, (2) the subcontractor is to bear the risk of the owner's nonpayment, or (3) the subcontractor is to be paid solely from the owner.[iii]

In this case, the court held that the "condition precedent" language in the clause was not plain and clear enough to sufficiently shift the risk of the owner's nonpayment to the subcontractor.  The court provided that a pay-if-paid clause requires a "clear, unambiguous statement that the subcontractor will not be paid if the owner does not pay" and that this clause was not sufficiently clear in this respect, despite the fact the provision contained the "condition precedent" language.  The court found that "condition precedent" was not sufficiently defined to inform both parties that the subcontractor would bear the risk of nonpayment by the owner.  Thus, the Court of Appeals reversed the trial court's ruling, and ruled in the subcontractor's favor that the clause was actually a pay-when-paid clause because it was not sufficiently clear to transfer the risk of nonpayment to the subcontractor.

AGC of Washington Subcontract Pay-if-Paid Provision

As mentioned above, Washington courts have not yet interpreted pay-if-paid vs. pay-when paid provisions.  However, the recent case from Ohio may shed some light on what Washington courts may focus on, if presented the opportunity.  The following pay-if-paid provision provided from the AGC of Washington Subcontract would likely be interpreted as a valid pay-if-paid provision based on the Ohio Court of Appeals opinion because it clearly and expressly states that payment to subcontractor is a condition precedent, and that the subcontractor bears the risk of the owner's nonpayment:

Payment Contingent on Owner Payment.  It is agreed that as a condition precedent to any payment by Contractor to Subcontractor hereunder the Contractor must first receive payment from the Owner for the Work of Subcontractor for which payment is sought.  Subcontractor specifically agrees that it is relying upon the Owner's credit (not the Contractor's) for payment, and Subcontractor specifically accepts the risk of nonpayment by the Owner.  At the reasonable request of Subcontractor, Contractor agrees to furnish such information as is reasonably available to Contractor from Owner regarding Owner's financial ability to pay for performance under the Main Contract.  The parties agree Contractor does not warrant the accuracy or completeness of information provided by Owner.

Comment:  The result in Ohio represents a departure from most jurisdictions' holdings that phrases such as "condition precedent," "if and only if," or "unless and until" constitute valid pay-if-paid provisions.  Although Washington courts have not yet tackled this issue, they likely will someday soon and may look to other courts' decisions for guidance.  Contractors should examine their subcontracts to make sure the pay-if-paid clauses are sufficiently clear, explicit, and contain the "required" language that the Ohio Court of Appeals indicated in the event that a dispute arises regarding the pay-if-paid provision.

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[i] Transtar Electric, Inc. v. A.E.M Electric Services Corp., 983 N.E.2d 399 (2012).

[ii] Id. (citing Kalkreuth Roofing & Sheet Metal, Inc. v. Bogner Constr. Co. (Aug. 27, 1998) 5th Dist. No. 97 CA 59, 1998 WL 666765.

[iii] Id.

Contractors often proceed to perform contract work while the details of a written contract are finalized.  In a recent Nevada case, a design build sprinkler subcontractor learned the hard way the risks associated with this all too common scenario.[i]  The case involved a warehouse construction project.  The general contractor, Precision Construction ("Precision"), solicited bids for the design and installation of the sprinkler system.  The subcontractor, Certified Fire Protection ("Certified"), submitted a bid of $480,000.  Shortly thereafter, Precision notified Certified that Precision had been awarded the job and forwarded a copy of its written subcontract.  The subcontract required that preliminary design drawings for the sprinkler work be submitted within two weeks. 

Certified objected to many of the terms in the subcontract (including the two week design deadline) but nevertheless proceeded to hire a designer to draft the sprinkler system designs.  Several weeks later, with other facets of project construction underway and the subcontract still unsigned, Certified submitted a progress billing of $33,575 for the design work which at that point was still unfinished.  Precision refused to pay the bill without a signed subcontract.  Certified proceeded to finish the design work and submitted the sprinkler system drawings.  The parties had several more communications about getting the subcontract signed.  Before a contract was signed, Precision learned that the subcontractor's design contained errors that needed correction.  Shortly thereafter, Precision terminated its relationship with Certified for failing to sign the subcontract, not providing an additional insured endorsement and for providing an incorrect design.  At Precision's request, Certified provided a final billing for work performed reporting costs of $25,185.04.  Precision refused to pay and Certified placed a mechanic's lien on the property and filed suit.

The trial court dismissed the case at the conclusion of Certified's evidence finding that no contract existed between the parties, and further that Certified could not recover in "quantum meruit" (a Latin phrase meaning "what one has earned"), or for unjust enrichment because the flawed design drawings could not be used by Precision, had no value, and thus did not confer any benefit on Precision.  Certified appealed.

On appeal, Certified conceded that the parties never reached agreement on the full design and installation contract, but contended that the parties had a contract for "design only" work because Precision had urged that Certified get started on the design.  The Nevada Supreme Court rejected this argument because there was no evidence that the parties had any agreement on either the price or time for performance for the design only.  Furthermore, witness testimony at trial established that a general contractor in Precision's position would never execute a design only subcontract because the design developed is specifically tailored for the subcontractor involved and is not useful to another installer.  Certified further argued it was entitled to compensation for unjust enrichment.  The court rejected this argument as well on the notion that Precision did not receive anything of value from Certified because the design work at issue could not be used by the replacement subcontractor, and was incomplete and incorrect.

Comment:  This case demonstrates the risks involved in starting construction without a signed contract.  While the subcontractor in this case ended up recovering nothing, had the facts and the nature of the work performed been different, it is not inconceivable that the general contractor would have had to pay both the original subcontractor for the work it performed, as well as any premium paid to the replacement subcontractor to take over the original subcontractor's work midstream.

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[i] Certified Fire Protection, Inc. v. Precision Construction, Inc., 283 P. 3d 250 (Nev. 2012).

The Washington State Supreme Court recently issued an opinion regarding courts' scope of review of arbitration decisions.  This case shows how difficult it is to overturn an arbitration decision.[i] 

A Port of Seattle ("Port") supervisor noticed a rope hanging from a ladder and asked an employee to take it down.  Instead, as a joke aimed at the supervisor, the employee thought it would be funny to tie the rope into a hangman's noose and hang it from the ladder.  Not surprisingly, the noose was not viewed as humorous by at least one of his minority co-workers.  That co-worker made a complaint and the Port fired the amateur knot-maker for violating the Port's zero-tolerance anti-harassment policy.  The employee was a member of the International Union of Operating Engineers, Local 268 ("Union").  The Union challenged the employee's termination.  The case proceeded to arbitration, per a collective bargaining agreement.

The arbitrator found that the knot-maker violated the Port's anti-harassment policy, but that he should not have been terminated because he was "more clueless than racist," and the employee's noose-on-a-ladder prank was "not racial" in nature.  The arbitrator considered the employee's twelve year history as a Port employee with no performance problems, and his history in the Navy - where he often played with rope and tied nooses to pass time - and decided that the employee should be suspended for 20-days without pay, rather than be fired. 

The Port appealed the arbitrator's decision and a King County Superior Court judge concluded that the arbitrator's decision was too lenient and violated the public policy against workplace harassment.  The King County judge then imposed a six-month unpaid suspension, and ordered the employee to make a sincere written apology, to attend diversity and anti-harassment training, and to be subject to four years of probation with a second harassment violation resulting in termination.

The Union appealed and the Court of Appeals affirmed the King County judge's ruling to vacate the arbitrator's decision, but held that the reviewing trial court could not create its own judgment.  The Union then appealed again and the Washington State Supreme Court accepted review.  The Supreme Court noted that its review was limited to whether the arbitrator exceeded his or her authority because further review "would weaken the value of bargained for, binding arbitration and could damage the freedom of contract," but that arbitration awards can be vacated if they violate "explicit, well defined, and dominant public policy." [ii]  The Court found that the policy against workplace harassment and discrimination was explicit, well defined, and dominant so it had authority to review and vacate the arbitrator's decision if the punishment was too lenient to not deter future discrimination.

The Court reiterated that its review was limited, and that it was bound by the arbitrator's findings of fact, which included the employee's non-racial understanding of the symbolism of the noose (he believed it related to "cowboys and Indians"), and the effect of the noose on other employees in the workplace.  Based on this limited scope of review and despite the employee's unacceptable and ignorant actions, the Court held that a 20-day unpaid suspension could "provide sufficient discipline to cause this or other employees to understand the serious nature of a noose in the workplace and thus prevent a similar incident in the future."[iii]  Thus, the Court held, the arbitrator's decision was not so lenient that it violated the public policy against workplace harassment and discrimination.

Lastly, the Court reiterated that a trial court reviewing an arbitration award has the authority to vacate the award, but that it does not have the authority to fashion its own remedy.  Instead, trial courts should remand to the arbitrator for further proceedings.

Comment:  Construction contracts often employ arbitration as the dispute resolution mechanism.  Although this case does not involve construction contractors, it does provide some insight into Washington courts' scope of review of arbitration awards and how difficult it is to vacate an award.  Even with these bizarre facts regarding the noose and the employee's questionable understanding of what the noose suggested, the Supreme Court did not find that the arbitrator's decision to suspend the employee for 20-days was so lenient that it violated the public policy against workplace harassment and discrimination.  This case demonstrates the finality of an arbitrator's decision such that parties subject to arbitration proceed knowing that it is extremely difficult to vacate an arbitrator's decision.

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[i] Int’l Union of Operating Engineers, Local 286 v. Port of Seattle, 296 P.3d 736, 117 Fair Empl. Prac. Cas. (BNA) 834 (2013).

[ii] Id. at 740 (quoting Kitsap County Deputy Sheriff’s Guild, 167 Wn.2d 428, 435, 219 P.3d 675 (2009)).

[iii] Id. at 742.