Sunday, March 26, 2017

Construction Insurance, Bonds, and Warranties

Doug Gallagher (left) and Rob Funk during their presentation at the March 23, 2017 CSI-Willamette Valley Chapter meeting (photo by Marina Wrensch)
Despite having worked in the trenches of the profession for over three decades now, construction insurance, bonds, and warranties remain among the most confusing and inscrutable matters of those requiring my everyday attention as an architect. Consequently, I looked to the March meeting of the Construction Specifications Institute – Willamette Valley Chapter as an opportunity to acquire clarity about a grouping of topics that are often the cause for misunderstandings and misconceptions amongst those in my profession. 

Our knowledgeable speakers for the evening were Doug Gallagher, Attorney of the eponymously named Douglas Gallagher Law Office PC , and Robert Funk, CIC of KPD Insurance and Risk Solutions. Their task was daunting—to describe the various forms of construction insurance, bonds, and warranties, and the salient features of each that distinguish their fundamental purposes—and they had only an hour within which to accomplish it. Given this constraint, the two men truly did their best to cover subject matter deserving the attention of an all-day seminar or much more. 

In a nutshell, Doug and Rob defined construction insurance, bonds, and warranties as follows: 

Construction Insurance
Fundamentally, insurance is a financial risk management tool, the primary concept of which involves the transference of the risk of potential financial loss from the insured to an insurance company in exchange for a monetary premium. 

Most everyone is familiar with insurance in one form or another, such as automobile insurance, homeowner’s insurance, or health insurance. Construction industry insurance is similar, protecting policy holders from catastrophic financial losses in the event of a claim or occurrence. 

Construction insurance includes coverage for general liability related to claims for bodily injury, property damage, personal injury, and others that can arise from construction-related activities. There are also professional liability policies, that protect individuals and companies from the full cost of defending claims of negligence, primarily for errors & omissions (after all, humans sometimes will make mistakes). Other forms of liability insurance include policies for managerial liability, and liability risks related to pollution, the actions of company directors and officers, cyber activities, and workers’ compensation. Excess liability policies provide coverage limits above those of an underlying liability policy, and are sometimes a contractual requirement on construction projects. 

Construction insurance also includes property insurance. Builder’s risk policies offer coverage in the event of property losses, protecting the insurable interests in materials, fixtures, and/or equipment being used in the construction or renovation of a building. Builder’s risk insurance can be purchased either by the owner or the general contractor, depending upon the terms of the Contract for Construction. It is usually a statutory requirement for public work. Inland marine coverage (a peculiar term as Rob pointed out) protects property in transit, as well as the instrumentalities of transportation (the bridges, roads, and piers, etc.). 

Property insurance purchased by one party can also provide coverage for the business or personal property of others, who become additional named insureds on the policy. This kind of coverage is often used in the instances where an owner may rely upon the insured contractor to provide protection of property the owner has paid for but is not yet part of the completed work (such as for materials stored in an off-site warehouse). 

Rob did leave us with cautionary words on the subject of construction insurance: Insurance, the saying goes, is like Swiss cheese. There’s a lot of substance to it but a lot of holes as well. It’s in everyone’s best interest to understand required and recommended coverages for any construction project. Doug seconded this point by saying it’s important to avoid limiting coverage through poor contract language. Equally important for everyone involved with a construction project is to review contractual requirements related to indemnification with their respective insurance providers. Finally, coordinating, verifying, and tracking certificates are keys to effectively managing insurance products. 

Surety Bonds
The easiest way to distinguish surety bonds from insurance policies is to understand that insurance provides protection from things beyond your control, whereas bonds come into play upon a breach of a contractual obligation. A bond is itself essentially a form of contract between a principal (the contractor) and the surety company (the “rich uncle” as Rob characterized it). It is a third party, usually the owner, who is the claimant when a bond is exercised. 

The various forms of surety bonds include bid bonds, performance bonds, payment bonds, and maintenance bonds: 

Bid bonds provide financial protection to the owner if a bidder is awarded a contract pursuant to the bidding process, but fails to sign the contract and provide required performance and payment bonds. The bid bond process also helps to screen out unqualified bidders and is often necessary to the process of competitive bidding.

Performance and Payment bonds protect an owner from financial loss in the event the contractor fails to perform the contract in accordance with its terms and conditions. With cause, an owner can declare a contractor in default and terminate the contract, and then can call on the surety to meet the surety’s obligations under the bond. 

Surety companies prequalify contractors based on their financial strength, construction expertise, and ability to perform the proposed work. By requiring surety bonds, owners present themselves with a level of assurance that the selected contractor will fulfill its contractual obligations successfully. Regardless, private owners do not always require contractors to furnish bonds because they increase the cost of a project. On the other hand, all public agencies do require performance and payment bonds. The bonds provide subcontractors and suppliers with remedies for losses for non-performance by the principal in the absence of construction lien rights on public projects.

Interestingly, Doug said AIA Document A312 – Performance Bond & Payment Bond does not entirely comply with the Oregon Regulatory Statutes. I’m not sure exactly how A312 fails to do so, but if I correctly recall what Doug said, it may have something to do with Oregon’s civil statutes of limitations. 

Maintenance bonds are purchased by a contractor and protect the owner of a completed construction project for a specified period against defects and faults in materials and workmanship. The purpose is to provide the owner with a means to ensure the cost to resolve problems is not an issue. 

A key concept associated with surety bonds is that a contractor who has had a claim filed against a bond must repay the surety for any compensation it makes to the obligee (the owner). 

One of the more vexing topics for anyone involved with construction is the purpose and true scope of warranties. Warranties are not to be confused with the correction period (usually one year in duration from the date of Substantial Completion), which is the time during which the contractor has the obligation to rectify deficient work. The correction period is associated with the contractor’s responsibility to generally correct deficiencies, whereas warranties apply to the need to complete a project in accordance with specific requirements of the contract documents. Warranties are a representation made by one party that another party can rely on. Warranties may be expressed (in writing) or implied (not directly stated but assumed to exist under common law). 

The problem with written warranties is that you need to fully understand what they say. Manufacturers are careful to only warrant what they directly control. Also, the scope of one manufacturer’s warranty may differ significantly from that of another manufacturer even though their products or systems may otherwise be similar and meet the project’s specified requirements; accordingly, it is incumbent on the design professional to clearly (and realistically) define warranty requirements and subsequently review submitted them with care to ensure the warranty provisions fully comply with them. 

What about “guarantees?” How is a guarantee different from a warranty? A guarantee is generally synonymous with a warranty; the difference is a guarantee is more akin to a surety bond, wherein someone makes a promise to be responsible for another’s debts or obligations. 

Class Limitations Periods in Oregon
Doug touched upon time limits on claims, which are important to be aware of under different circumstances. 

A statute of repose is intended to bar actions after a specified period has run from completion of a project. In Oregon, this period runs for 10 years for public projects, and 6 years for commercial projects. 

A statute of limitations differs from a statute of repose by being triggered by an “injury” or claim for damages. The time limits vary depending upon the nature of the claim. They are 6 years for breach of contract, 4 years for product liability, 2 years for upon disclosure of negligence, and 2 years from the date of discovery for design defects. 

If I understand correctly, this means a plaintiff can file a claim for, say, faulty construction within four years of identifying the problem if the statute of repose has not already been exceeded. 

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As I suggested earlier, I find construction insurance, surety bonds, and warranties to be complex, nuanced, and confusing subjects. I hope I have conveyed the gist of the presentation by Doug and Rob with as much fidelity and with as few inaccuracies as possible. Big thanks to the both experts for taking on a considerable challenge with good humor, grace, and effectiveness. 

Big thanks too to Jeremy Moritz of the Eugene Builders Exchange for making the EBE available as our venue for the evening. Jeremy sees great things in the future for the Builders Exchange, even as the nature of construction information management is in great flux. I agree, and hope to see the relationship between EBE and CSI Willamette Valley Chapter flourish in the future.


Tom Morris said...

Great information Randy. Thanks for sharing this. Go Ducks!

Randy Nishimura, AIA, CSI, CCS said...

Thanks Tom. GO DUCKS!!!