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The current economic downturn and credit crisis is causing significant problems for the construction industry. As new projects become scarce, competition for the limited work increases as companies seek to keep their employees working. This sounds like a “good” deal for owners but it comes with some added risks. Owners must balance the desire to accept the lowest bids received with the risk that the contractors submitting those bids are under-estimating costs and may default before the project is complete. This is also a risk to general contractors who rely upon low bids from subcontractors desperate to get new work. As such, owners and contractors on both public works and private construction projects must implement risk management strategies to minimize the risk of default.

Performance bonds are almost always required for public works projects as a way to protect the public while accepting the lowest bids through an open, competitive bidding system. Performance bonds are agreements among and between at least three parties: (1) the principal – the primary party who will be performing the underlying contractual obligation; (2) the obligee – the party who is the recipient of the principal’s obligation; and (3) the surety – the party who guarantees that the principal’s obligations will be performed. Under these agreements, the surety guarantees to the obligee that the principal will fully perform the underlying construction contract between the principal and obligee. In the public works context, the obligee is the government entity, the principal is the general contractor, and the surety is the bonding company. The bonding company guarantees to the government entity that the contractor shall perform in accordance with the terms and conditions of its underlying contract. If the contractor fails to meet its obligations, the surety becomes liable to the amount of the bond.

As in the public works arena, owners and contractors can also protect private construction projects by requiring performance bonds. The decision generally depends on two factors: the added cost of requiring the bonds, and the financial stability of the contractor or subcontractor submitting the bid. In times of economic hardship, the second factor becomes more important for several reasons. First, the cost of replacing a defaulting contractor or subcontractor is often much higher than the original bid. This is even more pronounced when the original bid was submitted at or below the actual cost to perform the contract. Second, the party who absorbs the cost of hiring the replacement contractor or subcontractor may have little or no luck collecting from a defaulting party who files for bankruptcy or closes its doors.

The increased cost on a project due to performance bond requirements is another important factor to consider. The cost is a premium based on the amount of the underlying contract and is adjusted as the contract amount changes. The owner generally pays this additional cost because it passes through the contractor’s bid and change orders.

Owners typically contract only with one prime contractor on a project. They must decide whether to incur the additional costs of requiring a performance bond to protect against the failure of the prime contractor to fully perform the work. Prime contractors, on the other hand, have multiple subcontracts with many different trade contractors on each project. Thus, in addition to evaluating the financial stability of each subcontractor, they must decide whether to incur the added cost of bonding each subcontractor or whether to bond on certain portions of a project. At the very least, contractors should take the time to identify which portions of a project, if abandoned by the subcontractor, would cause the most serious financial contract with the owner.

Owners and contractors can reduce the potential financial risk arising from a defaulting contractor or subcontractor by requiring performance bonds on a project. The rights arising under a performance bond may be lost, however, if the claimant does not comply with the bond’s technical claim requirements. As claim requirements are defined by the bond itself, owners and contractors should become familiar with its terms and conditions. Great care must be taken in providing all required notices to the appropriate parties in a timely manner. Additionally, bond claimants should retain detailed documentation regarding the defaulting party for the bonding company’s review. Finally, a lawsuit to enforce bond rights must be filed within the deadlines established by the bond.

Hard economic times create more competition in the construction industry. Thus, owners have the opportunity to contract for construction projects at a discount. By understanding and preparing for the risks that accompany this increased competition, owners and contractors can avoid turning a potential bargain into a substantial loss.

(Published in the Idaho Business Review, February 2009)

Contractors pride themselves on building projects that will stand the test of time. Unfortunately, however, claims often arise after final completion of a project. In these instances it is important to know that the Idaho Legislature has enacted statutory limitation periods which set a maximum period of time in which a contractor is liable for these claims.

A statute of limitations sets the maximum period for which a claim may be brought after a cause of action has accrued. A cause of action generally accrues when the person knows, or reasonably should know, that he or she has a claim against another party. A statute of repose, on the other hand, bars any claim brought after a specified period of time, regardless of the when the action accrued.

Claims against contractors arising after final completion of the project generally fall into two categories: (1) breach of contract actions by a party to the contract seeking economic damages; and (2) negligence actions by third parties seeking damages for personal injury or injury to property. The application of Idaho’s statute of limitations and statute of repose differ depending on which cause of action is sought by the claimant.

The majority of claims against contractors are founded on breach of contract. Generally, the rights and obligations of parties to construction contracts are memorialized by executing a written contract. Any action for breach of contract which is founded upon an instrument in writing must be brought within five years of the time of accrual. The statute of repose provides, however, that a contract action arising out of supervision or construction of improvements to real property accrues at the time of final completion of the project. As a result, claims founded on breach of a written construction contract are generally barred if not asserted within five years from the project’s final completion date.

The Idaho Supreme Court has even upheld this statute of repose where a contractor discouraged an owner from filing suit until the limitation period had lapsed. The contractor and owner unsuccessfully attempted to remedy the defects throughout the five year limitation period. Eventually, the owner remedied the construction defects for $3.4 million and brought suit against the contractor for breach of contract. The Court barred the owner’s claim for breach of contract because it was brought five years and four months after the parties executed the acceptance certificate for the project.

The Idaho statute of limitations for negligence claims accrues at the time the act or omission complained of occurs, and runs for a period of two years. Idaho courts distinguish between latent defects and patent defects when determining the time of accrual for negligence claims.

Patent defects are project defects that are apparent to a normally observant person upon its final completion. A negligence cause of action based on a patent defect accrues at the final completion of the project because it should have been discovered at that time. Therefore, the statute of repose for a negligence claim based on a patent defect is two years from the project’s final completion date.

Latent defects, on the other hand, are project imperfections that are not discoverable by reasonable inspection at final completion. A negligence cause of action based on a latent defect generally accrues when the party bringing the claim discovers the defect. Under Idaho’s statute of repose, however, any negligence cause of action against a contractor for damages resulting from latent defects in an improvement to real property accrues six years from final completion of the project if it has not previously accrued. Consequently, a negligence claim arising out of construction of improvements to real property must be brought within two years of discovery and in no event later than eight years following project completion. This eight year statute of repose is generally the longest period of time for which a contractor may be held liable for claims based on construction of a project under Idaho statute.

The Idaho statute of repose is helpful to contractors in two ways. First, it defines the minimum time period for which a contractor should preserve evidence related to a project. This can be vital for a contractor’s defense in the event a claim arises for either breach of contract or negligence. It also allows contractors to focus on current and future obligations without the threat of incurring liability from projects that have been complete for a reasonable period of time. Although these are the general principles related to the time in which a lawsuit can be filed against a contractor, an attorney should be consulted for particular circumstances.

(Published in the Idaho Business Review, August 2007)

Most contractors with experience on federal construction projects are familiar with the federal False Claim Act (“FCA”) which provides for civil and administrative penalties for anyone who knowingly submits or causes the submission of a false or fraudulent claim to the United States. The civil penalties range from $5,500 to $11,000 for each false claim submitted to the federal government, plus three times the amount of damages sustained by the government. The administrative remedies include suspension or debarment from work on future federal projects.

The FCA has evolved since it was introduced in 1863 to reflect a growing concern about fraud against the federal government. It was amended in 1986 to encourage private citizens known as whistleblowers to bring lawsuits against alleged violators of the FCA on behalf of the United States. In addition to providing financial incentives to whistleblowers, the FCA protects these individuals from retaliation if they bring a lawsuit against their employer. Recoveries under these lawsuits have dramatically increased over the years from less than $400,000 in 1986 to approximately $3,000,000,000 in 2010. The trend is a result of increased education to potential whistleblowers and the expanding scope of the FCA provided by the courts and statutory amendments.

Many states, including Montana, Nevada and California, have false claim statutes that address claims made to state governments based on the FCA model. Contractors should determine whether these statutes exist and what potential liabilities they provide when performing state and local government work in other states.

Although Idaho has not enacted a state false claims statute, a recent revision to the FCA has expanded its applicability to contractors performing state and local government work in Idaho. The number of contractors performing government work in Idaho has also increased due to the economic downtown over the last several years. Many contractors who previously bid primarily private construction projects are now bidding government projects. Contractors must be more mindful than ever of FCA and its reach.

The FCA was significantly expanded in 2009 to cover all projects funded at least in part by federal funds. A large number of state and local projects in Idaho are at least partially funded by federal money. These projects now fall within the scope of the FCA even without federal agency involvement.

Another expansion of the FCA impacts subcontractors and suppliers. Federal courts were historically divided on whether subcontractors, sub-tier contractors, and sub-tier suppliers were subject to FCA liability. In a 2008 decision, the Supreme Court found that the FCA applied to a subcontractor who makes a false statement to the prime contractor intending that it be passed through to the federal government. The Court rejected the notion that the FCA extended liability to any entity receiving federal funds directly or indirectly. In response to the decision, the 2009 revision expands the scope of the FCA to cover subcontractors and suppliers at all tiers.

FCA liability can arise in a number of situations at every stage of the project. Although each phase of a project presents different potential false claims, several bases for FCA liability are worth noting.

False statements in bids or negotiations often result in FCA liability. These statements can include everything from knowingly identifying an unavailable employee as the project manager or superintendant to identifying a sham disadvantaged business enterprise subcontractor for the project.

Certifications of payment and compliance with laws and regulations are also common bases for liability. Contractors must be vigilant to ensure that subcontractors comply with environmental regulations, the Davis-Bacon Act, and Buy America Act. Certification can also lead to FCA liability when a prime contractor withholds funds from a subcontractor or supplier due to an alleged breach of contract. A contractor should notify the government agency in writing anytime it requests payment that it does not intend to pass through to the party performing the work or supplying the material or equipment. Similarly, a prime contractor should never hold retention from a subcontractor when it has received full payment from the government.

Probably the most recognized act giving rise to FCA liability is false or inflated pricing which typically arises during the change order process. Contractors should avoid using the word “cost” when submitting pricing to perform extra work on government projects. If the contract requires that change order requests are based on cost estimates, contractors should carefully analyze all costs to ensure accuracy and retain supporting documentation. If a cost- based change order results in overpayment by the government, a contractor’s failure to refund the overpayment may result in FCA liability.

Given the expansion of the FCA, the steep liability for violations, and a substantially more aggressive attitude by the federal government toward enforcement, contractors that perform government work at any level should establish an internal education and compliance system to reduce potential liability under the FCA.

(Published in the Idaho Business Review, April 2011)

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