Failed Construction Projects: Common Disputes between Property Owners, Contractors and Subcontractors

Even with a strongly worded construction contract, disputes will potentially arise on a construction project.  However, gaining a clear understanding of the different types of construction disputes allows the parties to the initial agreement to negotiate provisions within a construction contract that will seek to reduce many of the risks that a significant dispute will arise. Additionally, provisions can be negotiated that can provide a mechanism for resolving any disputes in an expeditious manner so that the construction project can be completed in a timely manner. Therefore, this article will briefly touch on the major categories of disputes that may arise on a construction project between owners and the parties performing the actual construction on the project. Whenever construction is being considered, no matter the size of the project, it is a worthwhile endeavor to hire a construction attorney to draft or negotiate the agreement and provide guidance as to what the legal import of certain provisions are before anything is signed, and to provide legal advice on how best to avoid disputes both during, and after, your project. A small amount paid to an attorney up front may be able to save tens of thousands of dollars (or more) in legal fees if a one-sided or poorly drafted construction contract is executed.

Construction Payment Disputes

Payment disputes can arise at any point on a construction project after it starts. These disputes include everything from a contractor not paying its subcontractors or suppliers to an owner not paying a contractor and everything in between. Within this general category of disputes is a whole subset of other issues that can arise on a project, including: (1) contractors not following payment procedures; (2) payment applications being rejected by an architect, owner, title company or lender; (3) disputes over pay when paid or pay if paid clauses in contracts that state that a subcontractor cannot be paid until (or if) the owner pays the contractor (which are enforceable in Michigan as discussed in Berkel & Co Contractors v Christman Co, 210 Mich App 416, 418–419; 533 NW2d 838 (1995)); and (4) claimed defective or incomplete work. Although defective construction is a category in and of itself as outlined below, more times than not, payment disputes arise because the work has not been completed properly or there is a delay in approval of payment applications. If a payment dispute arises during the construction project, it could lead to a work stoppage and a delay in the completion of the project. Therefore, strong payment application and payment procedures specifically outlined in a construction contract are a must.

Construction Lien Claims

Depending on the type of project, a payment dispute may lead to a construction lien claim being asserted by any contractor who was allegedly not paid. This can create a serious problem that could jeopardize the entire construction project, especially if the project is being funded by a lender or through a title company. Many times, however, construction lien disputes do not arise until after a contractor has been terminated or the project is at, or near, completion. There is very little that can be done to safeguard against all construction lien claims in a construction contract; however, understanding the requirements of the Michigan Construction Lien Act, and following those requirements during the project itself can provide some comfort that the chance that a lien is ultimately recorded is lessened. Additionally, because Michigan has very specific requirements that must be followed by both the owner and the contractor in relation to a lien (or potential lien) claim, a qualified construction attorney should be retained to guide you through those requirements from the onset of any construction project.

Changes and Scope of Work Disputes

One of the biggest areas, if not the biggest area, of construction litigation, is disputes over a contractor’s scope of work. On most construction projects, the contractor has provided a bid or proposal based on a set of plans or drawings, or in viewing the site and talking to the owner. However, disputes arise when the condition of the project site is different than anticipated (this arises many times once excavation begins or when preexisting walls or structures are removed) or when a contractor and an owner disagree over whether a particular task is within the scope of what the contractor is contractually required to perform. Even further, there are times when the plans, drawings and specifications are inaccurate or incorrect and the construction contract needs to be adjusted based on what needs to be done to complete the project. A construction contract should have strong provisions that cover not only a procedure for changes, but a dispute resolution mechanism that allows for a quick decision so that the project is not delayed for a significant period while the parties attempt to work out any scope or change issues. To the extent possible, the actual construction contract should have explicit provisions that outline what is, and what is not, the responsibility of the contractor, and many times, this can be accomplished by incorporating the plans and specifications and the bid from the contractor into the actual contract.

Delayed or Failed Performance

Construction projects can become a problem when one party to the agreement is not performing in a timely manner, or at all. This could be an issue with an owner not making payment timely, but, in many cases, this happens because a contractor or subcontractor is falling behind on its work or has ceased construction. One contractor falling behind on a project, especially if that work is in the “critical path” of the project, can have a domino effect that delays all contractors from performing thereafter. For example, if a drywall contractor is scheduled to start work on a given day, but the electrical contractor has not completed its work installing the electrical system within the wall, the drywall contractor may end up with a claim for damages because of it not being able to complete its work until the electrical is installed behind where the drywall is to be placed. Another common issue that arises when there is a delay or failure of performance by a contractor is the type and amount of damages recoverable for the owner due to the delay. Many times, a replacement or supplemental contractor will need to be brought in to keep the project on track, or the owner will demand that the contractor work overtime or bring in additional labor. In an extreme situation, the failure of the contractor to perform timely will, as identified above, jeopardize the completion of the project causing damages to the owner by not being able to get full use of the property in the time expected. Once again, strong language that covers when an owner can replace a contractor, or supplement the contractor’s work, is critical for both the owner and the contractor to avoid a dispute during the project itself. The necessity of such strong language is buttressed by the fact that, in Michigan, if a construction contract does not specifically identify the time for completion (or for thresholds of performance within the contract), a “reasonable time” is presumed. Walter Toebe & Co v Dep’t of State Highways, 144 Mich App 21, 31; 373 NW2d 233 (1985). What will be deemed a “reasonable time” for completion is a question of fact which is ordinarily not to be decided until a full trial. As such, disputes about delays (and damages caused by delays) can be extremely complicated and expensive to prosecute and defend.

Termination or Suspension of Work

Sometimes, the delay or failure of performance on a construction project gets to a point where either the owner or the contractor must suspend performance or terminate the other party from the project. These disputes can also be extremely time-consuming and expensive. More times than not, the allegedly breaching party is going to contest that they have “materially” breached the contract or attempt to place the blame on another party, including the owner, the architect or other contractors on the project. Although Michigan law does stand for the proposition that a non-breaching party can terminate a contract with a party who materially breaches that contract (Lynder v. SS Kresge Co, 329 Mich 359, 369–70; 45 NW2d 319, 325 (1951)), disputes over material breach and proper termination are fact-intensive and if not resolved by settlement, usually involve a full trial in front of a judge or jury. Unfortunately, many construction contracts, especially residential construction contracts, have poorly drafted termination and/or suspension provisions in them. Negotiating a contract that has specific deadlines and milestones, as well as the ability for both the owner and contractor to suspend or terminate the contract in the case of a breach is critical.

Breach of Warranty and Defective or Faulty Construction

Most construction projects include express warranties, and, in Michigan, certain implied warranties apply both on behalf of the owner and the contractor. For example, construction contracts come with an implied warranty from the owner that the plans and specifications are accurate and suitable for both bidding and performing the contract, and if they are not, then the contractor cannot be liable for any damages caused by the plans and would be able to get the contract price increased due to any extra work caused by the inaccurate plans (this is referred to as the Spearin doctrine).  Earl L Reamer Co v City of Swartz Creek, 76 Mich App 227; 256 NW2d 447 (1977); United States v Spearin, 248 US 132 (1918). An owner also has implied duties to not interfere with the contractor’s progress (Walter Toebe, 144 Mich App at 34), to provide access to the construction site, and, maybe, to coordinate the work between different contractors to avoid unreasonable delays. If the owner breaches any one or more of these implied warranties or duties, then a claim for damages from the contractor (usually a change order to the contract) may be warranted.

In addition to any express warranties included in the construction contract itself, a construction contract in Michigan carries an implied warranty that the project will be performed in a reasonably workmanlike manner by the contractors. Nash v Sears Roebuck & Co, 383 Mich 136, 142-143; 174 NW2d 818 (1970). Even further, construction on newly built residential structures includes an implied warranty of habitability from the contractor. Weeks v Slavik Builders, Inc, 24 Mich App 621, 627; 180 NW2d 503 (1970).

Even the best worded warranty or promise cannot safeguard against every possible defect or issue that can arise during or after a construction project, however. Depending on the nature of the claimed defect, defective construction cases can be the most expensive to both prosecute and defend, and usually involve expert testimony and, eventually, a trial. Once again, there is little than can be done to protect either the owner or the contractor during the contracting phase because, it would be atypical for an owner to purposely slow down construction or for a contractor to go into a construction project anticipating that it will not perform in a “workmanlike” manner. The best things that can be done to safeguard against defective work or breaches of warranty, especially on a larger project, are to confirm that there is appropriate insurance coverage and to hire someone to monitor the work that is done on a regular basis and conduct on-site meetings with the various contractors (and the architect if the architect is performing construction management services). If the issue is discovered early and while the project is ongoing, the remedy is usually much easier to implement. Communication between the parties to the actual project is essential.

Another common issue that arises with defective work is insurance coverage. Recent unpublished cases from the Court of Appeals seem to indicate that an enforceable exception to coverage may exist regarding damages caused by a contractor’s own faulty or defective construction. This is generally referred to as the “Your Work” exclusion, and insurers rely upon that exclusion to deny coverage when the only claimed “damage” to the property is the work performed by that contractor.  See, e.g., Skanska USA Building, Inc v MAP Mechanical Contractors, unpublished per curiam opinions of the Court of Appeals, issued March 19, 2019 and December 28, 2021 (Docket Nos. 340871 and 341589). Even if the “Your Work” exclusion to coverage applies, the impact of the contractor’s defectively installed construction may cause damage to other parts of the property, and then, the exclusion would not apply. Even further, especially if there are multiple contractors or subcontractors working on the project, there is a strong likelihood that the defective construction will cause damage to improvements installed by another contractor, and in that case, once again, the “Your Work” exclusion will probably not apply. Regardless, confirming that every contractor who does work has strong insurance coverage, and that the owner and other parties to the project are named as additional insureds, is very important. The contract should require that the parties provide proof of insurance before any work is started and, if the project continues outside the coverage period in that proof of insurance, that proof be provided immediately that there is no lapse in coverage.

Conclusion

Every construction project—from a small remodel all the way to a large, new build—will involve a relationship between owner and contractor that may continue for many months or even years. The hope is that no issues will arise, and that the parties are all in agreement about things such as payment, scope of work, performance, and timing. However, very rarely does a construction project go without some sort of hiccup, but the hope is that the hiccup will not significantly delay the project or end up in litigation. As such, whether you are the owner, or one of the parties who will be performing the work on the project, the following steps should be considered:

  1. Retain qualified personnel (including architects and engineers) to either draft or review plans and specifications or a scope of work that outline exactly what is expected for the project. The scope of work should be as detailed as possible and outline what exactly is and what is not part of what each contractor is expected to do;
  2. If you are the owner, interview multiple potential contractors to find someone that you will feel comfortable working with. This is a two-way street. The contractor should also want to work with the owner because this is a partnership that may involve daily interaction for a lengthy period of time;
  3. During the bidding process, perform research into the other parties to the project to look for prior experience and complaints;
  4. If you are the party bidding on the work and have any questions about the scope of the work, get them answered or clarified, and make sure all such clarifications are in writing before submitting a bid and/or signing a contract;
  5. When the time comes to draft or negotiate the agreement, hire an attorney to help draft or negotiate that agreement to make sure that the parties’ expectations are met. Alternatively, the agreement can be drafted before the bidding begins so that the potential contractors are aware of the provisions that are important for the owner;
  6. Confirm that each contractor performing work has appropriate insurance coverage, and that the other parties to the project are named as additional insureds under the policy(ies);
  7. Hire a third-party to monitor the work being performed by the contractor during the construction, and that payment applications submitted by the contractor are accurate and correct. This also helps the contractor because the sooner the work and the payment applications are approved, the sooner payment should be made;
  8. If a problem arises, address it immediately by not only documenting the issue in accordance with the terms of the construction contract, but by offering to sit down and come to a resolution. If a potential insurable claim exists, make that claim immediately. This may be another situation where the attorney who you hired to help negotiate the contract will be helpful and can guide you through the process and what steps should be taken;
  9. Perform all tasks in accordance with the provisions of the construction contract and the schedule, including submission and approval of payment applications; and
  10. If a dispute cannot be resolved amicably, retain counsel immediately to discuss your rights and responsibilities. Although litigation should be only considered if everything else fails, it may become necessary, and prosecuting or defending an action can be significantly easier and less expensive if counsel is retained at an early stage.

There are usually many moving pieces when a construction project is undertaken. Because of this fact, issues can, and probably will, arise. Over the past few years, the COVID-19 pandemic and a shortage in both labor and materials has caused many projects to take significantly longer to complete than expected. However, many of the issues that arise on a construction project cannot be blamed on labor and materials shortages or the pandemic, and obtaining a clear understanding of what the universe of the issues can be, and agreeing to mechanism for dealing with them as they rise, should provide some comfort that the project will be completed with as great a probability as possible.

Adam Toosley is a member at Hirzel Law, PLC and focuses his practice on real estate litigation, zoning and land use, construction, and financial services litigation. Over the course of his career, he has represented property owners, landlords, condominium associations, lenders and all parties in the construction chain, handling all aspects of real estate-related disputes, including construction defect cases, payment and landlord-tenant disputes as well as real estate foreclosures, mechanic’s lien cases and fraud and business tort claims in state and federal court as well as in mediations and arbitrations throughout the United States. He is licensed in both Michigan and Illinois. He can be reached at (248) 480-8704 or at atoosley@hirzellaw.com.

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