Construction Law Blog

CASE ALERT—New Arizona Appellate Decision Enforces Narrow Form Indemnity Clause Against General Contractor

2008-11-25T03:11:00Z

On November 13, 2008, the Arizona Court of Appeals issued its decision in MT Builders, LLC v. Fisher Roofing, Inc., interpreting a “narrow form” subcontract indemnity provision which reads, in part as follows: “the [Subcontractor] shall indemnify and hold harmless [General Contractor] ... from and against all claims . . . arising out of [Subcontractor’s] work . . . to the extent caused in whole or in part by any negligent act or omission of the [Subcontractor]...”. The case involved a construction defect lawsuit filed by a condominium association against MT Builders (MTB), the general contractor, and at least nineteen subcontractors, including Fisher Roofing, Inc. MTB tendered defense of the case to its subcontractors and filed cross-claims for indemnity against the subcontractors. The subcontractors declined to defend MTB. Eventually, MTB settled the association's claims. In turn, MTB then settled its claims against all of the subcontractors except Fisher, the roofing subcontractor. The trial court considered competing motions for summary judgment filed by Fisher and MTB, and ruled in MTB’s favor on the indemnity claims, establishing $240,523 as the portion of the settlement attributable to Fisher. The appeals court reversed and issued three rulings that substantially impact owners, developers, contractors and subcontractors relating to indemnity obligations on construction projects.

ENFORCEMENT OF NARROW FORM INDEMNITY CLAUSES

First and foremost, the appellate court interpreted the “narrow form” indemnity clause to mean MTB can recover from Fisher only if MTB proves at trial that its losses and expenses were caused, in whole or in part, by Fisher’s negligence, with the recovery limited to the extent of that causation. In short, a narrow form of indemnity requires a trial to determine whether the indemnifying party (Fisher) is responsible at all and, if so, the indemnified party (MTB) will be entitled to recovery for that portion of the damages incurred in connection with the lawsuit against it.

INDEMNITY FOR SETTLEMENT AMOUNTS PAID

Given that most construction defect cases are settled, the second key ruling in MT Builders was that the appeals court also required MTB to demonstrate that the amount it paid to settle the Fisher-based claims was reasonable and prudent. The court listed a matrix of factors to be considered in deciding reasonableness and prudence, including (1) the association's damages, (2) the merits of the association's liability theories, (3) the merits of MTB’s defense theories, (4) MTB’s relative fault, (5) the risks and expenses of continued litigation, (6) any evidence of bad faith, collusion or fraud, (7) the extent of the association's investigation and preparation of the case, and (8) the interests of other parties. Under MT Builders, therefore, a party seeking indemnity for settlement amounts paid must establish at trial that the settlement was prudent and reasonable using a variety of factors.

NO DUTY TO DEFEND

The third and final important indemnity ruling is that Fisher did not have a duty to defend MTB, upon a tender of defense, because the word “defend” was absent from the narrow form indemnity clause at issue. The court found that the “to the extent” language precluded a duty to defend when the duty is not expressly provided because Fisher did not have an obligation to indemnify at all until a determination was made about the extent of Fisher’s fault. The court also suggested that the “to the extent” language in the indemnity may render even an express defense obligation unenforceable because the defense obligation could only arise after liability is established and that would be too late in the proceedings to be a meaningful defense. Practically speaking, that ruling means reimbursement of defense costs from the indemnifying party under narrow form indemnity clauses will not occur until the indemnifying party’s fault has been determined, with that degree of fault applied proportionally for reimbursement of the indemnified party’s attorneys’ fees, legal costs and other expenses.

LESSONS TO BE LEARNED

Contractors, owners and developers negotiating contracts should be aware that under the MT Builders decision, the practical effects of narrow form indemnity clauses, which limit a party’s indemnity obligations “to the extent” of fault caused by the indemnifying party, will be to require a trial determination of fault as a prerequisite to indemnity from the indemnifying party. Contract negotiators concerned about reducing the potential for litigation triggered to enforce an indemnity may wish to consider alternative, broader forms of indemnification consistent with applicable law. Further, before finalizing a settlement with a claimant, contractors, owners and/or developers who intend to seek indemnity under a narrow form indemnity clause with the requisite “to the extent” language must be careful to address and, perhaps, document during the settlement process the various factors under MT Builders relating to the reasonableness of a settlement. Additionally, MT Builders demonstrates the importance of including appropriate “defense” language in indemnity clauses, and the need to consider how an express defense obligation may be enforced if the indemnifying party’s obligations only arise after its liability is established. Finally, note that this decision relates to an indemnity clause that by its terms provided indemnity for “negligence” based claims only. Whether these principles apply to indemnification for damages resulting from the kinds of claims not addressed in the decision, such as contract breaches, remains to be seen.

Arizona Supreme Court Rules on Contract Provisions Capping Damages

2008-11-06T12:11:00Z

Professional service contracts often include provisions that limit the service providers’ liability to the amount received under the contract. In a decision earlier this year, the Arizona Court of Appeals ruled that, under the Arizona constitution, the decision whether and how to enforce such provisions must be made by the jury, rather than the judge. 1800 Ocotillo, LLC v. The WLB Group, Inc., No. 1 CA-CV 07-0037. In reaching this conclusion, the Court of Appeals analogized the provision to the defense of “assumption of risk,” which, under the Arizona Constitution, must be submitted to the jury.Fennemore Craig addressed this decision in a litigation update on February 25, 2008. In that update we noted that, “[i]t will be challenging for defendants, seeking to rely upon such provisions, to persuade juries to apply them in situations where the injured party’s damages greatly exceed the limit in the contract.”

The Arizona Supreme Court granted review of the Court of Appeals’ decision and reinstated the trial court ruling, holding “that the liability-limitation clause is neither contrary to public policy nor subject to Arizona’s constitutional requirement that the defense of assumption of risk always be submitted to a jury.” The underlying dispute between a developer and a survey company alleged that the survey company was negligent in failing to identify an existing right-of-way resulting in delays and modifications to the development. A provision in the contract between the developer and the survey company limited the developer’s recoverable damages for the survey company’s negligence to the “total fees actually paid” to the survey company. The trial court granted partial summary judgment in favor of the survey company, holding that this provision was enforceable. The court of appeals reversed on the grounds that, under the Arizona Constitution, issues regarding the enforcement of the provision should have been resolved by a jury and that the trial court was wrong in deciding the issue on summary judgment.

The Arizona Supreme Court disagreed with the “assumption of the risk” analogy, stating ‘assumption of risk’ as used in [the Arizona Constitution] . . . refer[s] only to defenses that effectively relieve the defendant of any duty.” The Court concluded the limitation of liability clause was not such a defense and, therefore, the issue of its validity and enforceability did not require determination by the jury.

The Supreme Court also discussed the benefits of such provisions in a manner to suggest it supported their judicial enforcement. The Court noted these provisions “may desirably allow the parties to allocate as between themselves the risks of damages in excess of the agreed-upon cap, which could preserve incentives for one party to take due care while assigning the risk of greater damages to another party that might be better able to mitigate or insure against them.” The Supremem Court did, howvere, recognize potential defenses to the enforceability of these provisions. Specifically, the Court noted that a cap on damages could be challenged by showing that the parties had not negotiated the provision, that the provision was applied in a manner contrary to the parties’ reasonable expectations, that the provision would cap damages at a dollar amount so low as to effectively eliminate the incentive to take precautions, or that the provision resulted from coercive or otherwise improper bargaining.

Bovis Strikes Back - Nevada Supreme Court Takes Mulligan On Pay-if-Paid

2008-10-31T04:10:00Z

In June, the Nevada Supreme Court released its opinion in Bovis v. Bullock, 124 Nev. Adv. Op. 39, 185 P.3d 1055 (June 2008). See this blog post on the case for details of the facts. In the Court's June opinion, it held that pay-if-pay provisions in subcontract agreements violate Nevada public policy. Although the subcontract at issue was entered into before the 2001 amendments to NRS Chapter 624, the Court declared in Footnote 33 that the prompt payment sections included in the 2001 amendments render pay-if-paid provisions unenforceable for contracts entered into after the amendments.

Now, the Supreme Cout has withdrawan its June opinion and replaced it with Bovis v. Bullock, 124 Nev. Adv. Op. 92 (Oct. 30, 2008). The new opinion changes nothing with respect to pay-if-paid provisions entered into before the 2001 amendments. The Court stuck with its previous conclusion "that pay-if-paid provisions are unenforceable because they violate public policy." The notable difference in this new opinion, however, is in Footnote 50. There, the Court states, "Pay-if-paid provisions entered into subsequent to the Legislature's amendments are enforceable only in limited circumstances and are subject to the restrictions laid out in these sections. 2001 Nev. Stat., ch. 341, §§ 5-6, at 1615-18." (emphasis added).

The statutes the Court refers to are NRS 624.624 and NRS 624.626. NRS 624.624 governs payment by higher-tiered contractors to lower-tiered subcontractors. If there is a written agreement that includes a schedule of payments, the statute requires payment on the due date or within 10 days of receiveing payment for the work, whichever is earlier. If there is no payment schedule, it reqires payment within 30 days after the lower-tiered subcontractor submits a request for payment or within 10 days of receiving payment for the work, whichever is earlier. NRS 624.626 provides lower-tiered subcontractors with the ability to stop work if they have not received payment as required and they meet certain notice prerequisites.

Where does this leave us? It leaves us with the following unanswered question: what are the "limited circumstances" in which pay-if-paid provisions entered into subsequent to the 2001 amendments are enforceable? The open question is the benefit of this opinion over the withdrawan Bovis opinion. In the former opinion, the Court conclusively said that pay-if-paid provisions entered into after the 2001 amendments were unenforceable. Period. But that issue was not before the Court in the case because the provision in question was entered into before the amendments to the statutes. With this new opinion, the Court allows itself the ability to address the question head on when it is duly raised. It is anyone's guess how the Court will interpret NRS 624.624 and 624.626, but at least the question is open, to be answered on an appropriate set of facts.

Is a Lien Claimant Entitled to Post-Judgment Attorney Fees?

2008-10-21T12:10:00Z

In Carl B. Barney v. Mt. Rose Heating & Air Conditioning, 124 Nev. Adv. Op. 71 (Sept. 18, 2008), the Nevada Supreme Court addressed, among other things: (1) whether NRS 108.237(1), which allows for recovery of attorney’s fees in a mechanic’s lien action, covers all fees incurred to enforce the mechanic’s lien, including those post-judgment attorney fees incidental to the lien’s enforcement through foreclosure; and (2) whether the district court erred in denying a post-judgment motion to enter satisfaction of the judgment because not all of the attorney fees were paid. Carl B. Barney (“Barney”) contracted with Reno Construction, Inc. (“RCI”) to renovate his house. RCI subcontracted with Mt. Rose Heating & Air Conditioning (“Mt. Rose”) to provide equipment and services as part of the renovations. Barney refused to pay for the work, which he determined was defective, and RCI and Mt. Rose filed mechanic’s liens against the property. Both RCI and Mt. Rose obtained judgments and decrees of foreclosure against Barney. Mt. Rose, prior to any foreclosure sale, garnished funds Barney held in a bank, and attempted to execute upon Barney’s personal property. Barney filed and won a motion to exempt his bank account from execution and to quash the garnishment. Mt. Rose sought supplemental attorney fees and costs (“First Mt. Rose Motion”); the court granted their request. Later, Mt. Rose filed a supplemental motion (“Second Mt. Rose Motion”), seeking fees for post-judgment matters, including the judgment’s execution, the garnishment, and the release of Barney’s bank funds.

While this supplemental motion was before the court, Barney paid Mt. Rose an amount to satisfy the judgment and the attorney fees and costs awarded in the First Mt. Rose Motion; however, Mt. Rose refused to recognize the judgment as fully satisfied. Barney moved the district court for an order directing the clerk to enter satisfaction of the judgment. Mt. Rose opposed the motion, asserting it was willing to provide a partial satisfaction, but was entitled to additional awards of attorney fees (requested in the Second Mt. Rose Motion), and the court denied the motion. Just over three (3) weeks after denying Barney’s motion, the court granted the Second Mt. Rose Motion for fees and costs. Barney appealed the post-judgment orders, arguing that the court was not authorized to award attorney fees incurred after the original judgment, and, even if authorized, the fees were unreasonable. Barney also argued the district court should have directed the clerk to enter the judgment’s satisfaction. The Court held that NRS 108.237(1) covers not only pre-judgment fees and costs, but also costs and fees that are incidental to the lien’s enforcement. Since the enforcement action ends only when the property is sold and the proceeds are distributed (or otherwise paid) and the lien is discharged or released, costs and fees up to this point are properly awarded (so long as they are incidental to the lien’s enforcement). Additionally, the Court held that since Mt. Rose had a motion for attorney fees pending at the time Barney tendered payment for the judgment, Barney was only entitled to partial satisfaction of judgment, and affirmed the finding of the district court.

Nevada Supreme Court Clarifies its Definition of a "New Residence" for NRS Chapter 40

2008-10-20T10:10:00Z

In ANSE, Inc., d/b/a Nevada State Plastering v. The Eighth Judicial District Court, 124 Nev. Adv. Op. 74 (Sept. 25, 2008), the Nevada Supreme Court clarified whether their definition of a “new residence”, as decided in Westpark Owners’ Ass’n v. District Court (123 Nev. ___, 167 P.3d 421 (2007); see blog post from June 27, 2008), precluded a homeowner who is not the home’s first purchaser from seeking remedies available under NRS Chapter 40 for constructional defects. In Westpark, the Court interpreted “new residence” as a product of original construction that has been unoccupied as a dwelling from the completion its construction until its sale. In this case, approximately 700 of the residences at issue in the constructional defect case were occupied as dwellings before the residences’ subsequent owners obtained title to the homes. Relying on Westpark, petitioners sought summary judgment as to their NRS Chapter 40 liability on claims related to those residences.

The Court found that petitioner’s expansion of “new residence” in Westpark as precluding a homeowner who is not the home’s original purchaser from obtaining remedies available under NRS Chapter 40 violates that chapter’s spirit, leads to unreasonable and absurd results, and ignores Westpark’s unique factual background. While rejecting petitioner’s claim, the Court recognized it needed to better clarify the definition of “new residence”. The Court indicated a “new residence” under NRS 40.615 is one that has remained unoccupied as a dwelling from the completion of its construction to the point of its first sale. Thereafter, subsequent owners of that residence, as claimants, may seek NRS Chapter 40’s residential constructional defect remedies, so long as the action is instituted within the applicable statute of repose.

Contractor's License is Intangible Personal Property that is Subject to a Claim for Conversion

2008-10-17T07:10:59Z

In M.C. Multi-Family Dev. v. Crestdale Assoc., 124 Nev. Adv. Op. No. 77 (Oct. 2, 2008), the Nevada Supreme Court concluded that a contractor's license is the personal property of the entity or individual named on the license. Therefore, it is subject to a claim of conversion if another entity or individual exercises "wrongful dominion" over the license. The qualifying employee of Walter Homes, Ltd. used Walter Homes' contractor's license to develop real property under a separate company, Crestdale Associates, Ltd., without the permission of the majority interest owners of Walter Homes. During trial, after the plaintiff's case in chief, the district court entered a directed verdict against the plaintiff's conversion claim. The district court found that Crestdale Associates had not "taken" the license.

On appeal, the Nevada Supreme Court determined first that a contractor's license embodies the intangible rights of the entity or person named on the license, and it is therefore intangible personal property subject to a conversion claim under Nevada law. Second, the Court concluded that a claimant for conversion of a contractor's license need not establish a physical "taking" of the license. "While the unauthorized use of a contractor's license does not involve an actual physical appropriation or 'taking' as the district court concluded, it nonetheless may constitute an act inconsistent with the rights of the titleholder. . . ." Accordingly, the Court reversed the district court's directed verdict and remanded the case for a jury trial on the conversion claim.

Note to qualified employees:
The Court specifically held that a person's status as the qualified employee does not give that person an "ownership or possessor interest in the corporate contractor's license and . . . such license can only be used by the individual or entity to which it is issued."

Court Holds Discretionary Immunity Protects Governmental Entity from Tort Liability in Accepting or Rejecting Bids for Public Works Projects

2008-10-17T07:10:59Z

The Nevada Supreme Court held recently that a Boulder City engineer's requirement that a low-bidding general contractor replace a particular subcontractor before the City would accept the bid was an action falling under discretionary immunity and precluded liability against the City for tortious interference of the subcontractor's contract. City of Boulder City v. Boulder Excavating, Inc., 124 Nev. Adv. Op. 65 (Sept. 11, 2008). Over a period of several years, Boulder Excavating, Inc. ("BEI"), as a general contractor, secured several accepted bids with Boulder City for public works projects. In 2000, however, a dispute between BEI and Boulder City over a road construction project occurred and was resolved by protracted arbitration proceedings, after which both parties claimed to have prevailed.

In late 2000 or early 2001, Boulder City solicited bids for the multimillion dollar Veteran's Memorial Park public works project. McComb Construction, a general contractor, submitted the lowest responsive and responsible bid. McComb's bid, however, included BEI as a subcontractor. Boulder City's engineer, Scott Hansen, requested that McComb seek permission to replace BEI with another subcontractor before accepting McComb's bid. McComb complied with the request, and the City awarded McComb the project.

BEI then brought suit against Boulder City and Hansen for, among other things, (1) intentionally interfering with the contractual relationship between McComb and BEI; (2) conspiring to evade the public bidding requirements of NRS Chapter 338; and (3) denying BEI of its rights to perform subcontract work. BEI's claims against Boulder City were based on Hansen's conduct as Boulder City's primary government actor. The district court found that Hansen was immune as a governmental actor under NRS 41.032(2). However, despite Hansen's immunity and that the claims against Boulder City were based on Hansen's actions, the court did not find Boulder City immune.

On appeal, the Nevada Supreme Court concluded that the district court erred. If Hansen was protected by NRS 41.032(2)'s discretionary immunity as a governmental actor, the agency for which he acted was also protected. Accordingly, the Supreme Court held that Boulder City was also immune because "Hansen was engaged in discretionary acts as defined by NRS 41.032(2), and because he was acting pursuant to his statutory authority in selecting subcontractors under NRS 338.141."

A potential footnote landmine:
In footnote 22, the Supreme Court addresses an argument of BEI that immunity should not be extended to Boulder City on BEI's claim of intentional inference with contract because "governmental actors are not entitled to immunity for illegal intentional acts or acts taken in bad faith." In addressing this argument, the Court concluded that because Boulder City had not accepted McComb's bid at the time of Hansen's actions, there was no contract with which to interfere. "[A] putative subcontractor named in a public works bid has no protected property interest in the public works contract because no cognizable claim to damages can arise before an award is made." In reaching this conclusion, the Court rejected BEI's argument under Clark Pacific v. Krump Constr., Inc., 942 F. Supp. 1324 (D. Nev. 1996).

In Clark Pacific, the Nevada Federal District Court concluded that a "psuedo contract" exists between the general contractor and a subcontractor after the public entity awards the project to the general but before a formal contract is signed between the general and the sub. The Clark Pacific court did not address BEI's argument on the issue of whether some sort of contractual relationship exists between the general and the sub before the public entity awards the contract to the general. Therefore, the Nevada Supreme Court is correct that Clark Pacific does not apply to BEI because BEI was substituted before Boulder City had awarded the contract to McComb. The Court, however, did not need to go so far as to say that, for a subcontractor, "no cognizable claim to damages can arise before an award is made." The Court's statement forecloses any possible claim for damages by a subcontractor before the public entity awards project. Depending on future cases that come before the Court, this may become one of those footnotes that the Court retreats from and limits to the facts of this case.

For a full copy of the case: http://www.nvsupremecourt.us/documents/advOpinions/124NevAdvOpNo65.pdf.

Contractor Liability Under Implied Warranties in Residential Construction

2008-08-30T01:08:16Z

The Arizona Supreme Court recently ruled that homeowners (and homeowner associations on behalf of homeowners) may sue residential homebuilders on an implied warranty of workmanship and habitability even if the homebuilder was not also the vendor of the homes and the homebuilder had no other direct relationship with the homebuyer. See The Lofts at Fillmore Condominium Assoc. v. Reliance Commercial Construction, No. CV-07-0416-PR (Ariz. filed Aug. 19, 2008) (http://www.supreme.state.az.us/opin/pdf2008/ACV070416PR.pdf).

How does this work in Nevada?
Nevada has not addressed the situation at issue in Arizona's Lofts at Fillmore case where the homebuilder was not also the vendor or a joint venturer with the vendor of the homes. The Nevada Supreme Court, however, has held that where a homebuilder is a joint venturer with the vendor, both the homebuilder and the vendor are jointly and severally liable to the homebuyer for breach of the implied warranty of habitability. See Radaker v. Scott, 109 Nev. 653, 855 P.2d 1037 (1993).

Here is what we know under Nevada law: (1) A hombuilder that is also a vendor is liable to a homebuyer for breach of the implied warranty of habitability. (2) A homebuilder that joint ventures with the vendor is liable to a homebuyer for breach of the implied warranty. The Nevada Supreme Court in Radaker extensively discussed the history of the implied warranty of habitability as being based in public policy. The Court agreed with numerous other courts that the implied warranty was based on sound public policy: "We agree with the virtual consensus among courts in our sister states that the implied warranty of habitability reflects a naturally expected and sound public policy." Radaker, 109 Nev. at 661, 855 P.2d at 1042. The Court then adopted the implied warranty for Nevada. Id.

By basing the implied warranty of habitability on public policy rather than on contract, the Radaker decision provides a stepping stone for the Nevada Supreme Court to go down the path of Arizona and extend the implied warranty when there is no contractual privity between the homebuilder and the homebuyer. The Arizona court in Lofts at Fillmore also based its decision to extend the implied warrant on public policy grounds. "We stressed in Richards that, given the policies behind the implied warranty – to protect innocent buyers and hold builders responsible for their work – any reasoning which would arbitrarily interpose a first buyer as an obstruction to someone equally deserving of recovery is incomprehensible." Lofts at Fillmore at 9-10 (internal quotations and citations omitted). It is not unthinkable then for Nevada to go one more step like Arizona has and hold that a homebuilder can be liable to a homebuyer for breach of the implied warranty even if the homebuilder is merely a contractor of the vendor and has no direct relationship with the homebuyer and gains no direct benefit from the sale of the home. We'll have to wait and see when such a case presents itself to the Nevada Supreme Court.

Regardless of how loosely Nevada may in the future apply the implied warranty of habitability, any claims based on the implied warranty by a homebuyer would almost certainly be subject to the requirements of Nevada's construction defect statutes (NRS 40.600 - 40.695). Therefore, at a minimum, a homebuilder would have to be given notice of the defect and an opportunity to cure it before an action can be commenced by a homebuyer.

Contractors Must use E-Verify to Verify Workers Employment Eligibility for all Future Federal Contracts

2008-07-09T01:07:21Z

On June 6, 2008, President Bush issued an Executive Order amending Executive Order 12989, which directs all Federal departments and agencies to require contractors, as a condition of each future federal contract, to agree to use an electronic employment eligibility verification system (designated by the Secretary of Homeland Security) to verify the employment eligibility of: (1) all persons hired during the contract term by the contractor to perform employment duties within the United States; and (2) all persons assigned by the contractor to perform work within the United States on the federal contract.

The Department of Homeland Security recently designated E-Verify as the electronic employment eligibility verification system to be used pursuant to Executive Order 12989.

For more detailed information see here.

E-Verify can be accessed through the Department of Homeland Security's website.

Nevada Supreme Court Decides Enforceability of Contractual Lien Waiver Provisions

2008-06-28T01:06:27Z

The Nevada Supreme Court recently addressed two issues of concern to contractors and owners: (1) the enforceability of lien waiver provisions, and (2) the enforceability of pay-if-paid provisions. Lehrer McGovern Bovis, Inc. v. Bullock Insulation, Inc., 124 Nev. Adv. Op. 39 (June 2008), is the latest saga from the Venetian mechanics' lien lawsuits. The case involved the owner and general contractor attempting to foil a subcontractor's lien foreclosure and breach of contract claims by asserting a lien waiver provision and a pay-if-paid provision in the subcontract agreement. The Court declared that Nevada's public policy "favor[s] contractors' rights to secured payment for labor, materials, and equipment furnished." Based on this policy, the Court struck down both the lien waiver provision and the pay-if-paid provision. The subcontract agreement at issue predated the legislative amendments to the mechanics' lien statutes, NRS Chapter 108, requiring specific forms for lien waivers and predated the amendments to NRS Chapter 624, which created Nevada's prompt payment statutes. Although not at issue, the Court thought it necessary to state, without explanation or analysis in what will become known as the infamous Footnote 33, that the amendments to Chapter 624 creating the prompt pay statutes, "make pay-if-paid provisions entered into subsequent to the Legislature's amendments unenforceable."

Mechanics' Lien Waivers
The subcontract agreement between subcontractor Bullock Insulation and general contractor Bovis incorporated a provision from the general conditions in which Bullock Insulation promised "'not [to] suffer or permit any lien or other encumbrance to be filed' against the project." The Court noted that the "lien waiver provision applies regardless of whether Bullock Insulation received any payment" and therefore concluded that "such provision violates public policy, as it fails to secure payment for Bullock Insulation."

The Court assured that not every lien waiver provision violates public policy and that the enforceability of a lien waiver clause must be decided on a case-by-case basis. Limiting the enforceability of lien waiver provisions to the facts of each case seems like a fair result, but the Court gave no guidance as to what types of lien waiver provisions would be enforceable without payment in full. The public policy proclamation coupled with NRS 108.2453(1), which prohibits the waiver of mechanics' lien rights unless the appropriate forms specified in Chapter 108 are completed and payment made, suggest that without payment in full, mechanics' lien rights can not be waived.

Pay-If-Paid Provisions
More disturbing than the Court's treatment of the lien waiver provision is its decision on the pay-if-paid provision. The subcontract agreement contained a pay-if-paid provision whereby Bullock Insulation's right to payment for its work was contingent upon payment by the owner to Bovis. The Court held the provision unenforceable because "a pay-if-paid provision limits a subcontractor's ability to be paid for work already performed" and therefore "such a provision impairs the subcontractor's statutory right to place a mechanic's lien on the construction project." Rather than limit the holding to a case-by-case analysis, however, the Court concluded that all pay-if-paid provisions that were entered into before the amendments to NRS Chapter 624 are unenforceable.

What's more, in Footnote 33, the Court proclaimed,

We note that in 2001, the Legislature amended NRS Chapter 624 to include prompt payment provisions contained in NRS 624.624 through 624.626, which make pay-if-paid provisions entered into subsequent to the Legislature's amendments unenforceable. (emphasis added).

The Court acknowledged that the amendment to Chapter 624 "does not affect our analysis here because it is not retroactive." Yet, the Court rang the bell anyway.

A major problem with Footnote 33 is that the prompt payment statutes in Chapter 624 do not render pay-if-paid clauses unenforceable. In fact, NRS 624.626(1)(b) recognizes that pay-if-paid or pay-when-paid provisions regularly exist in subcontract agreements and grants the subcontractor the remedy of stopping work when a higher-tiered contractor does not timely pay a lower-tiered contractor even if the higher-tiered contractor has not been paid by the owner. Additionally, pay-if-paid provisions do not necessarily eliminate a subcontractor's mechanic's lien rights. Even with a pay-if-paid provision in a subcontract agreement, the subcontractor remains able perfect and foreclose on its mechanic's lien against the owner. Despite these remedies, Footnote 33 effectively makes the general contractor a lender of the owner by requiring general contractors to pay subcontractors when the general has not received payment from the owner. This is true even if the subcontractor has assumed the risk of nonpayment by agreeing to a pay-if-paid provision.

Where To Go From Here
Undoubtedly, the Bovis decision will draw a lot of criticism. A motion for rehearing would not be surprising. The decision makes it more important than ever for general contractors to verify the financial viability of owners to complete a project. So far, the decision appears favorable to subcontractors that are subject to now-unenforceable lien waiver and pay-if-paid provisions. Owners should expect post-Bovis contracts to attempt to allocate more heavily to the owner the general contractor's risk of liability to subcontractors for owner nonpayment. But even a reallocation of risk cannot protect a general contractor from an insolvent owner.

Does NRS Chapter 40 Apply to Completed Blueprints for an Unfinished Residence?

2008-06-27T01:06:25Z

The quick answer is "No". In Pankopf v. Peterson, ___ Nev. ___, 175 P.3d 910 (2008), the Pankopfs entered into a contract with Peterson for residential design and drawing services for a personal residence. Peterson provided blueprints for a personal residence, and excavation for the residence’s construction began. The plans failed to identify the types of trees that would be planted on the site as required by the Pankopf’s homeowner’s association, and the excavation process was halted. According to the Pankopfs, a number of deficiencies in Peterson's work ultimately prevented them from building their residence. The Pankopfs brought suit against Peterson, alleging that Peterson's plans contained numerous design defects, mistakes, omissions, and inaccuracies that prevented them from constructing the residence. Peterson subsequently filed a motion to dismiss under NRCP 12(b)(5), arguing that the Pankopfs failed to comply with certain requirements set forth in NRS Chapter 40 that applied in constructional defect cases. The Pankopfs argued that they did not make a claim for relief based on any constructional defect within the scope of NRS Chapter 40.

The district court granted Peterson's motion, concluding that because NRS 40.615 defines a constructional defect as a “defect in the design ... of an alteration of or addition to an existing residence, or of an appurtenance” and NRS 40.605 defines an appurtenance as including “the parcel of real property,” the Pankopf’s claims fell within NRS Chapter 40's purview. The Court, on appeal, stated that because no residence existed, the parcel of real property cannot constitute an appurtenance within the meaning of NRS 40.605. In addition, the Pankopfs primarily complained of mistakes in Peterson's plans for their house, not in the design of any appurtenance. Therefore, the Court concluded that the Pankopf’s claims did not fall under NRS Chapter 40 based on the plain language of the definitions set forth in NRS 40.615 and NRS 40.605(1). The Court also addressed the meaning of the term “new residence” as defined by NRS Chapter 40, citing their recent decision in Westpark Owners' Ass'n v. District Court (see below). Specifically, the Court held that “a residence is ‘new’ when it is a product of original construction that has been unoccupied as a dwelling from the completion of its construction until the point of sale.” Since the Pankopf’s residence has not been completed, it cannot constitute a “new residence” for the purposes of NRS Chapter 40. As such, NRS Chapter 40 does not apply to completed blueprints for unfinished residences.

Court Defines New Residence and Addresses Buyer Waivers of Constructional Defect Claims

2008-06-27T01:06:59Z

In Westpark Owners’ Association v. Eighth Judicial District Court, ___ Nev. ___, 167 P.3d 421 (2007), the Court addressed three (3) issues concerning NRS Chapter 40 (constructional defects): i) the definition of “residence”; ii) the definition of “new”, in the context of a residence; and iii) the effect of a general waiver of constructional defects in a sales contract. Westpark Associates, LLC (“Westpark”) purchased a partially completed condominium project out of bankruptcy, and completed an additional 108 units, but due to market conditions decided to lease the 108 units as apartments, and did so from 1997 through 2003. Westpark started selling the units to the general public, and each contract required the buyer to waive “any” possible construction defect claims. The converted condo owners began experiencing problems with their units, and the Westpark Owners’ Association (the “Association”) served Westpark with a formal Chapter 40 notice.

The district court entered partial summary judgment in favor of Westpark, declaring generally that Westpark had “no liability” in connection with the development or sale, relying on several conclusions of law which were revisited by the Nevada Supreme Court. First, contrary to the district court’s reasoning, the Court found that the mere fact the units were originally built as apartments does not prevent them from meeting the definition of a residence. The Court found the event conferring “residence” status is the transfer of title to a home purchaser. Second, the Court interpreted “new” as a product of original construction that has been unoccupied as a dwelling from the completion its construction until its sale. Although the units in this matter did not meet the definition of “new”, the Court found that if Westpark altered or repaired the units before their sale, they would fall under NRS 40.615. Finally, while NRS 40.640(5) allows a contractor and homebuyer to stipulate to a waiver of any potential claims under NRS Chapter 40, the “waived” constructional defect must be disclosed to the buyer in clear language before the purchase of the residence. Here, the waivers did not disclose any constructional defects; they stated only that certain defects “may” exist and listed a number of potential defects. This general disclaimer language was not sufficient to waive any claims pursuant to NRS Chapter 40.

Court Creates Reasonable Threshold Test For Constructional Defect Pre-Litigation Notices

2008-06-27T12:06:32Z

In D.R. Horton v. Eighth Judicial District Court, ___ Nev. ___, 168 P.3d 731 (2007), D.R. Horton, Inc. (“D.R. Horton”) constructed 414 residences in 138 buildings in the First Light at Boulder Ranch Community in Henderson, Nevada (“First Light”). Believing that numerous constructional defects may exist in each residence, First Light hired experts to assist it in preparing an NRS 40.645 pre-litigation notice of constructional defects. The notice was formulated after using visual and invasive testing in a small representative sampling of homes in the community. First Light did not provide D.R. Horton with the addresses or the expert report of the homes that were tested. Using the information they found, the First Light experts simply extrapolated the percentage of homes in which they believed each defect existed throughout the community. D.R. Horton moved the district court for a declaratory judgment, stating that First Light’s NRS 40.645 notice was unreasonable and thus statutorily insufficient. The district court denied the motion, and D.R. Horton filed a writ petition challenging the district court’s order. To address the problem of what satisfies the “reasonable detail” requirement of NRS 40.645, the Court formulated the “reasonable threshold” test to be used when pre-litigation notices contain extrapolated data. The scope of the extrapolated notice must be narrow.

First, the homeowner’s expert must test and verify the existence of an alleged defect in at least one of the homes in each subset of homes included within the scope of the extrapolated notice. Additionally, the claimants must provide the address of each home tested and clearly identify the subset of homes to which the pre-litigation notice applies. In order to provide valid pre-litigation notice, claimants must narrow the scope of their extrapolated notice. They should investigate and identify a subset of homes within the community that has the purported defect. If they genuinely believe that every home in the community may have the alleged defect, then the claimants should test and verify the defect in at least one home from each subset of homes in the community and extrapolate the percentage of homes within each subset that they believe are likely to contain the defect. The court emphasized that the legislature intended NRS 40.645 to provide Nevada contractors an opportunity to inspect and repair defects in the homes they construct. To that end, a pre-litigation notice must contain reasonable detail so that a contractor, who makes the business decision, can decide whether to inspect and repair. The Court also concluded that a claimant cannot utilize the phrase “to the extent known” in NRS 40.645(2)(c) to justify withholding pertinent information from a pre-litigation notice, and that NRS 40.645(4)(c) requires a claimant to disclose the expert opinions and reports in its possession that were used to prepare its pre-litigation notice.