Consider this: A building hasn't experienced any leaks, but its owner files a breach-of-contract claim against you based on a consultant's report. The consultant claims you failed to comply with contract specifications and your workmanship was defective. Are you liable to reroof the building or pay for the cost of reroofing based on the breach of contract?
Or consider this: After selecting the desired shingle color from samples you present to him, a homeowner makes a claim against you because the installed shingles are not uniform in color and the disparity is apparent from certain angles depending on the time of day and how sunlight strikes the roof. Can the homeowner recover from you the cost of removing the recently installed shingles and reroofing the home?
The answers to these questions are based on the law of damages. Specifically, the legal issue is: What is the measure of damages applicable to an owner's claim?
There are two basic approaches courts apply to measure damages for breach of a construction contact. Damages can be calculated based on the cost to repair the contract deficiency or diminution in value of what was constructed. In other words, an owner may be entitled to the cost of correcting the deficiency in construction or the difference in value between how the building was built versus how the building was to have been constructed.
Which rule to apply?
The purpose of contract damages is to place the nonbreaching party in the same position it would have been in had the contract not been breached. However, doing so does not necessarily mean the building in question must be in the same physical condition it would have been had there been no deviation from the contract specifications.
Although case law and statutes pertaining to construction contract damages vary among states and parties may stipulate remedies in contracts, the general rule is damages for a breach of contract should be equal to the cost of bringing the construction in accordance with the contract unless the repair or completion would result in "economic waste."
Courts have various definitions of economic waste. For example, economic waste occurs when:
If the cost of repair is excessive or disproportionate to the value to be gained from performing the corrective work, the diminution in value rule will be applied to avoid economic waste. (See "What is economic waste?" page 47, for more information.)
To determine which measure of damages to apply, courts often are motivated by a desire to obtain a fair result rather than taking a doctrinaire approach. In many cases, there may not be a difference between damages based on cost of repair versus diminution in value because the diminution in value is based on the cost of repair.
A court should consider a case's specific facts and circumstances and balance the owner's right to obtain substantially what the contract required against a desire not to create a windfall or unreasonable result. Some courts have said that whether the cost of repair or diminution in value rule applies depends on the particular case. Other courts say whichever rule results in lesser damages should apply.
Cost of repair
The cost of repair measure of damages is intended to give an owner the amount of money needed to bring a building in accordance with a contract. The cost of repair measure clearly applies in cases where a defect can be repaired or cured without undue expense. An owner is entitled to recover the amount reasonably expended or that will reasonably need to be expended to remedy the construction defect.
An owner does not need to have spent the money at the time of trial or arbitration to recover it. For repairs already completed at the time of trial or arbitration, the cost of repair is proved by actual costs incurred in good faith by the owner to repair the defective work. If the repairs have not yet been made, the cost of repair must be proved by reasonable estimates prepared by independent experts or qualified construction personnel. An owner must prove the cost of repair by evidence of incurred costs for performed repairs or estimated costs for repairs that have not yet been made.
Repair costs include replacement or reconstruction costs when replacement is needed to satisfy contract requirements. Repair costs typically will be presumed to be reasonable and incurred in good faith but can be challenged. If a client introduces evidence of repair costs and you contend the repair costs are unreasonable or improper, you have to prove the damages should not be recovered.
Although an owner is entitled to recover reasonable costs to repair defects, to the extent that repairs improve, enhance or provide the owner with a better or more expensive building than what was originally contracted, you obviously would not be liable for the upgrades. An owner is not entitled to receive more than the benefit of the original bargain.
An owner also has a duty to mitigate damages. This means an owner must take reasonable steps to reduce damages, injuries or costs and avoid further loss. An owner will not be allowed to recover damages that could have been avoided. Although an owner has a duty to mitigate damages, you, as the defending contractor, have to prove a failure to mitigate if you believe the owner failed to take reasonable steps to mitigate the damages the owner seeks to recover.
Diminution in value
When repair costs are disproportionate to the benefit to be obtained, courts are likely to find that awarding damages based on cost of repair would constitute economic waste. In these cases, damages are measured by diminution in value. Using this measure, courts evaluate the market value of a building as constructed versus the market value of the building as it was to have been constructed and award the owner the difference.
Establishing damages based on diminution in value is more difficult than proving damages based on cost of repair. Independent real estate appraisers or other experts present their opinions regarding how a property's value has been affected by the deficiency in construction. Sometimes, courts even use the cost of repair as evidence of the difference in value.
Some cases
In the 1970 case of Salem Towne Apartments Inc. v. McDaniel & Sons Roofing Co., the owner of an apartment complex in Winston-Salem, N.C., brought suit against a roofing contractor and shingle manufacturer because of shingle discoloration.
After seeing shingle samples, the owner selected three-tab strip black shingles manufactured by Lloyd A. Fry Roofing Co., Chicago. The apartment complex consisted of 153 units in 16 buildings. The original 1967 roofing construction contract between Salem Towne Apartments and McDaniel & Sons Roofing was for $19,500.
When roofing had been completed on two buildings, the owner ordered McDaniel & Sons Roofing to stop because discoloration appeared under certain light conditions. Lloyd A. Fry Roofing then issued a letter stating the discoloration was caused by dust applied to the backsides of the shingles so they would not stick to each other while bundled and that some dust particles were clinging to the granule surface. Once there were hard rains, the dust would wash off.
Based on Lloyd A. Fry Roofing's letter, the owner directed McDaniel & Sons Roofing to proceed with the job. Construction was completed, and the owner took possession of the buildings in December 1967 and January 1968. However, contrary to Lloyd A. Fry Roofing's assurance, the discoloration persisted and was apparent when the court viewed the apartment roofs in March 1970.
Salem Towne Apartments filed suit against the roofing contractor and shingle manufacturer and presented evidence that it would cost $25,000 to replace the shingles. The roof systems were completely functional; there was nothing wrong with the installation; and all the apartments were rented. Based on the economic waste concept, the court ruled the owner was not entitled to recover the cost of repair because of a lack of uniform color.
Instead, the court ruled: "[I]t appears clear that the diminution of value rule applies to a construction case where the cost of tearing off the roof would be prohibitive, whereas the actual loss of value to the owner due to the appearance of the roof is minimal. … Under these circumstances, the damages recoverable by the plaintiff are to be measured by the difference in the value of the apartment project as it presently stands and its value had the color of the roof been uniform."
Recognizing it would be difficult to establish the actual diminution in value, the court acknowledged the roofs' aesthetic appearances might cause some minor concern to prospective buyers in a future sale and awarded the owner $7,500 from the manufacturer.
A similar decision was reached by the Oregon Court of Appeals in the 1982 case of Thomas v. Schmidt d/b/a/ Tri-Tex Roofing & Siding Co., which involved a contract for reroofing a house and garage. The evidence showed the work was done in a workmanlike manner, but there was some discoloration and/or shading on both roofs. The court said discoloration would constitute a breach of contract and might affect the roofs' aesthetic values. The homeowner sought to recover damages based on the cost of repair rule, which would allow recovery of the amount necessary to cure the defects. To cure the defects, reroofing of both buildings, at a cost of $2,160, would be needed.
The trial court ruled and the Oregon Court of Appeals affirmed: "Given the fact that, except for the shading, these roofs are satisfactory, an award for such repair is disproportionate to the damages actually suffered by Plaintiff and would result in gross economic waste. Accordingly, the Court rules that the proper measure of damages is not the cost of repair but rather the amount by which the value of the completed projects was reduced by the shading problem."
Instead of a damage award of $2,160, the court awarded $325.
Using economic waste
Although applying the economic waste rule usually results in measuring damages based on diminution in value, the economic waste rule has been applied so the owner is entitled to recover damages based on a less expensive means to solve the problem created by the construction deficiency compared with removal and reconstruction.
The 1972 decision of the Arizona Court of Appeals in the case County of Maricopa v. Walsh and Oberg Architects Inc., involving waterproofing of an underground parking deck, illustrates this.
In 1962, Maricopa County, Ariz., embarked on a project to construct a new county complex in downtown Phoenix. Construction was completed and accepted by the county in 1964. A portion of the project consisted of a steel-reinforced concrete slab, about 400 feet long by 200 feet wide and 9 to 10 inches thick, laid over an underground parking area. Aluminum conduits, which carried an electrical system, were embedded within the slab. The slab's specifications stated the concrete must be impermeable. Extensive landscaping, including sidewalks, dirt, rock, shrubs, grass, fill, statues, benches, surface lighting and a drainage system, were placed on top of the slab.
However, following the county's acceptance of the complex, cracks developed in the slab's underside and moisture leaked into the parking area. The county sued the project's architect and contractor. The evidence presented at trial was that leakage was from two sources: inability of the specified caulking material to adequately bond the expansion joints in the slab and the specification of a substance known as Anti-Hydro,® which was added to the cement in the slab to make it impervious to moisture. Anti-Hydro contained calcium chloride. When the calcium chloride contacted the aluminum conduits embedded within the concrete slab, which were alternately moistened and dried, chemical corrosion of the aluminum occurred. This caused the aluminum to expand to several times its original volume and led to corrosion and cracks in the slab.
To be sure the slab was impermeable as required by the contract, it would be necessary to remove the landscaping on top of the slab, cover the slab with a waterproofing membrane and then replace the landscaping. The cost of this repair varied from $350,710 (architect's estimate) to $498,169 (county's estimate); 75 percent of these costs would be incurred in the landscaping's removal and replacement.
Although the slab would not be made impermeable as required in the original construction contract, evidence was introduced at the trial that the problem could be solved in a far less costly manner by installing a cathodic protection system into the concrete slab, which would chemically counteract the corrosive process, and installing drip pans on the slab's underside.
At the time of trial, 40 percent of the project's electrical system had been replaced for $3,636.23. Instead of embedding new electrical conduit in the slab, electrical conduit was installed underneath the slab, bypassing the embedded electrical system; this method had proved satisfactory.
The estimated cost of replacement of the balance of the electrical system in this manner was $8,429. There was testimony that the damage to automobiles could be eliminated by installing drip pans on the underside of the slab at a cost of $14,000; this remedy already had been used by the county to a certain extent during the past six years at a cost of $2,500. With the addition of the cathodic protection system, no further damage to the steel reinforcement in the slab or the embedded aluminum conduits would occur.
The cost of installing the cathodic protection system and drip pans, replacing electrical circuits and repairing any damaged vehicles and other incidental damages, including additional maintenance costs, over the life expectancy of the entire complex was estimated to be $107,358.
When the county was awarded $107,358 from the architect, it appealed, claiming it was entitled to recover $358,000 to $498,169—the estimated costs to make the slab watertight.
Applying the economic waste concept, the Arizona Court of Appeals said "the purpose of money damages is to put the injured party in as good a condition as that in which full performance would have put him, but that does not mean that he is to be put in the same specific physical condition."
Quoting a 1932 treatise on contract damages, the Arizona appellate court wrote: "'Sometimes defects in a completed structure cannot be physically remedied without tearing down and rebuilding, at a cost that would be imprudent and unreasonable. The law does not require damages to be measured by a method requiring such economic waste.'"
You, too, can use the economic waste doctrine, not only as a defense to ward off a potential large damage award based on the cost of repair but as a means to recover costs when an owner's requirement to redo work in accordance with the original contract requirements constitutes economic waste.
The 1992 case Granite Construction Company v. United States dramatically illustrates this application of the economic waste doctrine.
In this case, the contract required that water stops be installed a certain way. The contractor breached the contract by installing the water stops differently. The government insisted the contractor remove water stops already embedded in vertical cold joints between monolithic concrete slabs and install water stops in strict compliance with the specifications. The contractor complied with the government's order and filed suit to recover its costs.
At trial, the contractor proved the water stops as originally installed exceeded by more than 20 times the project safety margin and could withstand water pressure more than 40 times greater than what would ever be exerted. Under these circumstances, the U.S. Court of Appeals for the Federal Circuit ruled the contractor was entitled to recover the $3.8 million the contractor spent to remove and replace the water stops.
Summing up
If you breach a construction contract, you will be liable for resulting damages. In addition, you will be liable for damages to the extent that the owner did not receive what the owner was entitled to receive in accordance with the contract's terms. Usually, an owner will be able to recover the cost to make the construction conform to what was contractually required unless the cost of repair would constitute economic waste. If the cost of repair is disproportionate to the benefit to be obtained or the loss of value resulting from the breach, seek to have damages calculated based on diminution in value rather than cost of repair.
If repairs or remedial work an owner undertakes provide the owner with a better product than what was stipulated in the construction contract or the owner fails to take reasonable steps to avoid damages that could be avoided, be prepared to prove betterment or failure to mitigate damages, thereby reducing the damages for which you may be found liable.
Stephen M. Phillips is a partner with the Atlanta-based law firm Hendrick, Phillips, Salzman & Flatt.
What is economic waste?
The economic waste concept often is applied when remedying a defect would require destruction of the building, substantially impair the building as a whole or unreasonably destroy work already performed.
The most obvious example of economic waste in a construction context occurs when a house has not been built on the lines shown on construction plans. Because it would be economically wasteful to tear down and rebuild the house per the plans, the cost of repair rule is disregarded and the diminution in value measure of damages is applied.
Courts use the economic waste doctrine in construction cases to measure damages based on diminution in value rather than cost of repair as a means to reach a reasonable result.
The classic case applying the economic waste doctrine is a 1921 decision written by then New York Court of Appeals Judge and later U.S. Supreme Court Justice Benjamin Cardozo in Jacob & Youngs v. Kent. In this case, the construction contract required the contractor to install plumbing pipe manufactured by the Reading Pipe Co. Mistakenly, the contractor installed plumbing pipe manufactured by Cohos Pipe Co. The Cohos pipe had the same physical properties as the Reading pipe and otherwise complied with the contract requirements, but it was not the pipe required.
After most of the pipe had been installed, the owner discovered the discrepancy. To remove the already installed pipe and replace it with the correct pipe required that a wall be torn down and rebuilt. The owner insisted the contract requirements be followed and demanded the contractor remove and replace the installed pipe with the specified pipe. When the contractor refused, the owner filed suit. At trial, the contractor proved the pipes were equal in all material respects and the installed pipe did not diminish the building's value.
In ruling that the proper measure of damages in these circumstances would be the diminution in value and not the cost of repair, Cardozo wrote: "[T]he measure of the allowance is not the cost of replacement, which would be great, but the difference in value, which would be either nominal or nothing…. The owner is entitled to the money which will permit him to complete, unless the cost is greatly out of proportion to the good to be attained. When this is true, the measure is the difference in value."
Applying the law pertaining to economic waste may help you if you face a breach of contract claim seeking substantial damages if damages are determined based on cost of repair. You can use the economic waste rule as part of a defense against an owner's claim to recover the cost of reconstruction, and it may even serve as a basis to obtain recovery when the owner insists construction be redone according to the original specifications when the design intent has been realized and the cost of redoing the work is disproportional to the benefit.
COMMENTS
Be the first to comment. Please log in to leave a comment.