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CONSTRUCTION LAW REVIEW

November 2004 SUBSTANTIAL COMPLETION BLUES

Every owner and general contractor is generally familiar with the concept of "Substantial Completion." From a scheduling standpoint, it is the focal point of everyone's attention from the very beginning of a project until -- well, when the project is substantially completed. Despite this intense focus, disputes about whether substantial completion is actually achieved on a given date abound across the construction landscape. These disputes often turn into litigation for no reason other than the parties were not very clear on what they meant by "substantial completion" when they signed the construction contract. From the standpoint of courts and judges, "substantial completion" is important in deciding whether a party has breached a construction contract, and when relevant statutes of limitation begin to run with respect to defective work. Most courts use the same definition utilized in most construction contracts, namely that substantial completion occurs when the owner is able to use the project for the purpose intended, or something similar to that. Most construction contracts, including the AIA forms, have that kind of generic description of substantial completion. Of course, there are many other contract provisions that are tied to substantial completion, including liquidated damages, delay damages, payment of retainage and similar matters. However, despite the significance of substantial completion to owners, contractors and subcontractors alike, it is quite apparent to construction litigators that very little attention is paid to the actual definition of substantial completion used in a construction contract, or the unique circumstances of a particular project. This is surprising, given that all construction projects are clearly not alike. In many cases, the generic definition referenced above simply does not get the job done for any of the parties involved. It rarely works for the owner. Properly defining substantial completion is critical from the standpoint of meeting expectations and avoiding disputes. The concept of beneficial occupancy, the standard contract formulation, can be subject to many different interpretations. A contractor might say that a certificate of occupancy (whether temporary or permanent is a debate all by itself) is dispositive as to the determination of a substantial completion date. An owner might construe the situation more strictly, and say that the

Inside:

Announcement Case and Legislative Updates By State Florida Georgia Mississippi New York South Carolina Virginia Federal Case Update Mark Your Calendar In the News Construction Tips: Lien Waivers: What Do They Really Mean? 3 3 3 3 4 4 4 5 5 5 6 6

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owner should be allowed to occupy and enjoy the building without any further disruptions (with punch list items confined to the exterior of the building, for example). The beneficial occupancy definition certainly makes perfect sense if one is talking about a brand new, vanilla office building in the suburbs with one tenant. However, it makes absolutely no sense when talking about a hotel or residential project. On a residential or hotel project, the idea of punch list work being performed in an occupied hotel room or an occupied apartment is unthinkable to the developer and the resident. If the owner cannot turn the hotel room or apartment over to the resident to be enjoyed without plumbers doing punch lists, then the project cannot generate revenue for the owner. Being able to "occupy" the project, or receiving a certificate of occupancy, has no particular relevance to this owner or developer. Other projects pose similar problems. If the issue is the construction of retail shell space, how much work has to be completed by the landlord's contractor in order for the tenant to accept the premises for fixturing? If the issue is interior retail tenant space, how much work has to be completed by the contractor for the retailer to open for business? What does the lease say about the work that has to be completed, and when? In these circumstances, that may be the most important question. All of these questions must be answered if the definition of substantial completion in the construction contract is going to be accurate and useful in preventing a dispute at the end of the project. For some of our clients that develop or construct many different types of projects, we often suggest that they leave the substantial completion definition blank in their form contracts. The hope is that the project manager will look at this issue along with all of the other business terms, and come up with a definition that makes sense for the particular project involved. This definition may need to be very detailed and contain a laundry list of items bearing on the issue of "substantial completion." This could include specific site work items (site lighting, paving, etc.) that have nothing to do with the building itself, but which bear on the issue of substantial completion, at least a "substantial completion" that meets the expectations of the developer. In the apartment example, one should determine what common area work has to be completed in order to achieve substantial completion, above and beyond completion of the residential units. As noted above, the difficulty of determining when substantial completion has been achieved can have enormous consequences. Delay damages, payments and retainage releases are almost always tied to substantial completion. As a result, a lot of money is riding on whether substantial completion has been achieved on a particular project, and by what date. It is therefore critical that the parties to the contract avoid, if at all possible, arguing about the definition of substantial completion and what has to be done to achieve that status on the project. ­ Deborah Cazan

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CASE UPDATES BY STATE

Florida

Subcontractor's Failure to Separately Register and License Its Fictitious Name Did Not Invalidate Its Subcontract In Martin Daytona Corp. v. Strickland Const. Services, Florida's Fifth District Court of Appeals ruled that a subcontractor's failure to separately register and license the fictitious name under which it entered into a subcontract did not invalidate the subcontract. In this case, the subcontractor sued to collect amounts allegedly owed by the general contractor at the end of a project. The subcontract contained an arbitration clause and the contractor moved to stay or abate arbitration arguing that the clause was unenforceable because the subcontractor entered the subcontract under a fictitious name, without separately registering and licensing the name, in violation of Florida's contractor licensing laws. The Fifth District ruled that the subcontract is enforceable, notwithstanding the subcontractor's failure to register and obtain a separate license. The court determined that a recent amendment to the contractor licensing requirements clarified that a contract is not invalid for the contractor's failure to register or obtain a license under its fictitious name. 881 So. 2d 686 (Fla. App. 5th DCA Aug. 27, 2004)

ANNOUNCMENT

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The Construction and Government Contacts Group is pleased to announce the relocation of one of its attorneys, Brook A. Clark, to the firm's New York office where she will join partner Daniel J. O'Neill as the second attorney from the Construction and Government Contracts Group in that office. For many years, Alston & Bird has represented national and international clients who have engaged our services to handle transactional and adversarial matters throughout the Northeast. The relocation of Ms. Clark allows the Construction and Government Contacts Group to enhance its ability to provide local support to clients who need business and adversarial advice on construction and government contracts matters in New York City and throughout the Northeast.

Georgia

Georgia Legislature Enacts General Contractor Licensing Statute The Georgia Legislature recently enacted a contractor licensing scheme designed to cover both "residential contractors" and "general contractors." O.C.G.A. § 43-41-1 et. seq. The law will go into effect when appropriations are budgeted for the licensing board, which did not occur during the 2004 legislative session. The definition of "contracting" is very broad and includes not only performing the construction or the management of the construction of improvements to real property for an owner, but also merely offering to undertake such services for, or submitting a bid to, an owner. The definition also includes contracting work performed by a construction manager at risk. Generally, "residential contractors" must obtain a license if they contract directly with an owner for a value over $2,500 or receive a fee over $2,500. However, no minimum dollar amount appears in the statue for "general contractors." The statute prescribes both criminal penalties and civil sanctions for failure to comply with the statue. Notably, like most jurisdictions, an unlicensed contactor may not enforce its contract. An unlicensed contractor also loses all lien and bond rights it may otherwise have had. Contractors who perform construction work in the state of Georgia should play close attention to the new contractor licensing requirements and should take steps to ensure they will be in compliance when the statute becomes effective.

Mississippi

Mississippi Supreme Court Requires Contractor to Prove Objective and Subjective Impossibility to Prevail on Defective Design Claim In Evan Johnson & Sons Constr., Inc. v. State, the Mississippi Supreme Court held that the state and its architect were not liable on the contractor's defective design claim because the contractor failed to prove the impossibility of constructing the building according to the design. The contractor believed that it could not build the roof in accordance with the plans and specifications. Despite the contractor's objections, the state instructed the contractor to install the roof as designed. After the contractor attempted to build the roof in a manner contrary to the plans and specifications, the state rejected the contractor's work. The contractor sued the state and the architect alleging defective design. The court rejected the contractor's defective design claim because the contractor failed to prove both subjective and objective impossibility. "Because [the contractor] failed to prove any other contractor was unable to comply with the original design and specifications and because [the contractor] failed to attempt to construct the roof according to the original design and specifications," the contractor's claim for defective design was without merit. 877 So. 2d 360 (Miss. 2004)

New York

Failure to File Notice of Lending Costs Bank $1.9M The New York Court of Appeals recently reminded banks of the importance of filing a Notice of Lending. In Aspro Mechanical Contracting Inc. v. Fleet Bank, N.A., 7, the court ordered Fleet to pay a group of subcontractors $1.9 million dollars that it had applied to its mortgages on a residential housing project. Fleet loaned Berry Street Corporation $12 million dollars secured by the assignment of Berry's rights in a development contract with the New York City Housing Authority (NYCHA). Fleet applied NYCHA's payments to its outstanding mortgages on the property. Several unpaid subcontractors (including Aspro) sued Fleet, alleging that the Bank had diverted trust assets in violation of the state's lien law. The court found that Fleet was a trustee of the funds received from NYCHA, and had a fiduciary duty to use those funds to pay for improvements to the property. Fleet breached that duty by using trust funds to repay its own mortgages and was therefore liable for the subcontractors' claims. Fleet could have avoided liability entirely if it had filed a "Notice of Lending" with the county clerk. By doing so, it would have notified trust beneficiaries that trust assets were being used to discharge Berry's debt. 805 N.E.2d 1037 (N.Y. 2004)

South Carolina

Right to Compel Arbitration Not Waived By Delay, Pre-Trial Activity and Litigation Costs In Patten Grading & Paving, Inc. v. Skanska USA Building Inc., two attorneys from Alston & Bird's Construction and Government Contracts Group successfully argued an appeal before the U.S. Court of Appeals for the Fourth Circuit. The appellate court reversed the lower court's ruling that the contractor had waived its contractual right to compel arbitration when it waited eight months after commencing litigation before moving to compel arbitration. In reversing, the court of appeals assessed several facts raised by the subcontractor and relied upon by the district court, including the contractor's alleged eight-month delay in moving to compel arbitration, limited pre-trial activity and discovery, and the subcontractor's incursion of $5,800 in litigation costs, and concluded that taken in isolation and together, these facts did

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not constitute actual prejudice sufficient to demonstrate waiver of the right to compel arbitration. 380 F.3d 200 (4th Cir. 2004)

Virginia

Surety's Notice of Claim Against Principal, Coupled With Right and Opportunity to Defend, Sufficient to Bind Surety To Judgment by Default Entered Against Principal In American Safety Casualty Ins. Co. v. C.G. Mitchell Construction, Inc., the Supreme Court of Virginia held that a judgment by default entered against the principal on a payment bond as a discovery sanction was binding and conclusive on the surety for purposes of summary judgment. Relying on the Eleventh Circuit Court of Appeals' decision in Drill South, Inc. v. International Fid. Ins. Co., 234 F.3d 1232 (11th Cir. 2000), the Virginia Supreme Court announced that a general rule has emerged whereby "a surety is bound by any judgment against its principal, default or otherwise, when the surety had full knowledge of the action against the principal and an opportunity to defend." 601 S.E.2d 633 (Va. 2004)

FEDERAL CASE UPDATE

Expiration of One-Year Limitations Period on Appeal of Contracting Officer's Decision Precludes Claim Where Contractor Failed to Retrieve Decision from Post Office Box In Riley & Ephriam Constr. Co. v. United States, the Court of Federal Claims dismissed the contractor's appeal of the contracting officer's denial of its $300,000 claim. Under the Tucker Act, a contractor must file an appeal of a contracting officer's final decision in the Court of Federal Claims no later than one year after the date of the contractor's receipt of that final decision. Here, the contractor received notice in its post office box that a package sent by certified mail was "received" by the U.S. Post Office, but failed to retrieve the package before it was returned to the sender after 29 days. The contracting officer also sent the decision via facsimile to the contractor's attorney and received confirmation of receipt, but the attorney claimed never to have received the facsimile. The court found that the facsimile, combined with evidence suggesting successful transmission, constituted "receipt" by the contractor's agent. The court also found that receipt by the Post Office was sufficient as well, so that the contractor's suit in the Court of Federal Claims, filed over a year after both the post office box receipt and the facsimile, was untimely. 61 Fed. Cl. 405 (2004)

MARK YOUR CALENDAR

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Stephen M. Reams is speaking on "Construction Project Finance and the Impact of NAFTA" at the Trilateral Symposium at Universidad Pan Americana, November 10-11, 2004, Guadalajara, Mexico. Brian K. Fielden is presenting "Managing Risk in Hotel Development and Construction" at the Academy of Hospitality Industry Attorneys' November 2004 Meeting, November 11-13, Dallas, Texas. Robert L. Crewdson and Brian K. Fielden will present "Managing Risk in Hotel Development and Construction" at the Americas Lodging Investment Summit, January 18-20, Los Angeles, California.

Partners John I. Spangler III, William H. Hughes, Jr., and Robert L. Crewdson were all recognized in Best Lawyers in America 2005-2006 in the area of construction law. Robert L. Crewdson presented "Construction War Stories II -- Another Year, More Stories" at the 2004 ICSC U.S. Law Conference in Hollywood, Florida. Jonathan D. Crumly, Sr. presented "Evidence in the 21st Century: a Construction Lawyers' Guide" at the May 2004 American Bar Association Forum on the Construction Industry's Annual Meeting in Scottsdale, Arizona. William H. Hughes, Jr. presented "A Practical Course of Action for Claim Prevention and Avoidance" at the national conference of the Construction Management Association of America (CMAA) in San Antonio, Texas on September 13, 2004. Robert L. Crewdson and William H. Hughes, Jr. made presentations at the Institute for Continuing Education's "Construction Law for the General Practioner" seminar in Atlanta on October 14, 2004. Mr. Crewdson also chaired the seminar. Associate John S. Ducat III co-authored written materials. Jonathan D. Crumly, Sr. co-authored "Preventing War Over Mold Claims," an article appearing in the July 2004 New York Law Journal. Jonathan D. Crumly, Sr. was quoted extensively in a front page article in August 30, 2004, edition of the South Carolina Lawyers Weekly reporting on the Patten Grading decision (see Case Updates for details of the decision).

CONSTRUCTION TIPS: LIEN WAIVERS: WHAT DO THEY REALLY MEAN?

Lien waivers are a staple of construction projects. Everybody knows the importance of obtaining a lien waiver, although many owners and contractors never bother to collect them. But where do the waiver forms themselves come from? And what do they really mean? Unfortunately, many owners, contractors and subcontractors cannot really answer these questions, and the consequences are often devastating. The most generic form of lien waiver simply waives a contractor's right to assert lien claims on a project. For interim pay applications, this waiver of lien rights might extend through the date of the waiver, or might be effective only to the extent of payment. This is an important distinction with a difference. From the owner's perspective, it is preferable to use a lien waiver form that waives lien rights through the date of the waiver, as this may serve to waive lien rights for as yet unresolved claims for extras or delay. A contractor, however, will want to limit the lien waiver's coverage to the payment that is being received. Owners can obtain additional protection by including language that waives contract claims as well as lien claims on the project, through the date of the lien waiver. The purpose of this additional language is to "bring the project current" and give the owner comfort that no hidden or unknown claims exist at the time of each progress payment, or at the time of final payment.

IN THE NEWS

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In these cases, it is important that a contractor read the waiver form, and understand the difference between a lien waiver and a claim waiver. When the waiver releases contract claims as well as lien rights, the company signing the waiver will have released its right to recover costs or damages for pending change orders or delay claims that are otherwise being submitted or processed on the project. The waiver could result in an inadvertent and unintentional release of claims under the contract that are otherwise entirely valid. These waivers are enforced according to their terms like any other legal document, particularly because waivers are sworn documents. Courts are loath to allow an attack by a contractor on its own sworn lien waiver. Therefore, when signing a waiver that includes a release of contract claims (as well as lien rights), a contractor should carefully list and exclude those claims and matters that are still pending. Most owners find the list of excluded claims to be acceptable, as their main intent in using the claim waiver is to obtain information on claims that might be in the offing. Owners should ensure that this list of claims is as specific as possible to preclude any argument as to what is included in that claim at a later date. Another issue regarding lien waivers that requires careful attention is the issue of whether the state in which the project is located has restrictions on the type of waivers that can be used. For example, in the South, Georgia and Florida have statutory lien waiver forms, and the statutes generally provide that all waivers must be substantially in the form provided in the statute to be effective. In the West, Arizona and California have very strict requirements on the form of a lien waiver. There are a few other states with similar requirements. If a waiver contrary to the terms of these statutes is used, it will be deemed unenforceable. Most of the statutory waiver forms are merely waivers of lien, and not claims. While these statutes often do not speak to the issue of whether claim waivers can be included in a waiver form (and there are no cases bearing on this issue at the present time), Arizona and California do, in fact, prohibit claim waivers. Other states, like Florida and Georgia, do not seem to prohibit claim waivers, although there are no cases that would permit a final answer to this question. Additional states will likely pass lien waiver form provisions in the future, and a contractor going into any state for the first time should always check to make sure their form complies with any statute that exists. Owners and contractors should pay careful attention to the lien waivers used on every project they undertake. If statutory lien waivers are required, the parties should ensure they have the proper forms. They should read and analyze the lien waivers to obtain a clear understanding of what rights and claims are being waived every month. If owners and contractors pay close attention to statutory requirements, and the contents of lien waivers, they can avoid unintended and potentially devastating consequences. ­ Aubrey B. Waddell

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This Construction Law Review is published by Alston & Bird to provide a summary of significant developments to our clients and friends. It is intended to be informational and does not constitute legal advice regarding any specific situation. This material may also be considered advertising under the applicable court rules.

MEMBERS OF ALSTON & BIRD'S CONSTRUCTION AND GOVERNMENT CONTRACTS GROUP

John I. Spangler, III Practice Group Chair 404-881-7146 [email protected] Jeffrey A. Belkin 404-881-7388 [email protected] Deborah Cazan 404-881-7667 [email protected] Brook A. Clark 212-210-9462 [email protected] Robert L. Crewdson 404-881-7291 [email protected] Jonathan D. Crumly, Sr. 404-881-7336 [email protected] Daniel F. Diffley 404-881-4703 [email protected] John S. Ducat III 404-881-4934 [email protected] Brian K. Fielden 404-881-7496 [email protected] J. Andrew Howard 404-881-4980 [email protected] William H. Hughes, Jr. 404-881-7273 [email protected] Daniel J. O'Neill 212-210-9522 [email protected] Stephen M. Reams 404-881-7731 [email protected] Aubrey B. Waddell 404-881-4932 [email protected]

ATLANTA One Atlantic Center 1201 West Peachtree Street Atlanta, GA 30309-3424 404-881-7000 CHARLOTTE Bank of America Plaza 101 South Tryon Street Suite 4000 Charlotte, NC 28280-4000 704-444-1000 NEW YORK 90 Park Avenue New York, NY 10016-1387 212-210-9400 RESEARCH TRIANGLE 3201 Beechleaf Court Suite 600 Raleigh, NC 27604-1062 919-862-2200 WASHINGTON, D.C. 601 Pennsylvania Avenue, N.W. North Building, 10th Floor Washington, D.C. 20004-2601 202-756-3300 www.alston.com

If you would like to receive future Construction Law Reviews electronically, please forward your contact information including e-mail address to [email protected] Be sure to put "subscribe" in the subject line.

© Alston & Bird LLP 2004

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