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Lee-Ann Brown focuses her practice on construction and government contracts. Her practice is primarily concentrated on the litigation of contract claims for construction clients, including owners, general contractors and subcontractors on private and public projects. View articles by Lee-Ann

Federal Court Expresses Public Policy Concern Regarding Economic Loss RuleIn Prestress Services Industries of TN, LLC v. W.G. Yates & Sons Construction Co., 280 F.Supp.3d 908 (N.D. Miss. 2017), the United States District Court for the Northern District of Mississippi faced a “rather interesting issue of tort law” involving the economic loss rule that has not been addressed by either the Mississippi Supreme Court or the Fifth Circuit. The action arose out of a project to construct a garage on the University of Mississippi campus. In dicta, the court opined that the economic loss rule should not be used to immunize an engineer’s defective design of precast concrete components that did not meet the applicable seismic standards.

The project, which was located in the New Madrid fault’s earthquake zone, was being managed by the Ole Miss Athletic Foundation (Ole Miss). In addition to employing W.G. Yates & Sons Construction (Yates) as the general contractor, and AECOM Design as the architect, Ole Miss had a purchase order with Prestress Services Industries (PSI) to design, fabricate, and deliver, the precast concrete components of the garage. PSI, in turn, hired an engineering firm, Hoch Associates (Hoch),[1] to design the precast concrete components.

The project ultimately suffered delays and cost overruns, which led to numerous disputes. Pertinent here, Yates brought an action against Hoch, asserting, among other things, a negligence claim for Hoch’s failure to design the precast concrete components in accordance with the applicable seismic requirements.

Hoch moved for summary judgment on Yates’ negligence claim, arguing that it was barred by the economic loss rule. In asserting the economic loss rule as a defense, Hoch claimed that the precast components were goods or products and thus, that Yates was barred from recovering any economic damages—such as damages for delay—because the economic loss rule restricts recovery of damages arising out of a defective good to damages for physical harm and excludes recovery for purely economic losses.

Yates argued that the economic loss rule didn’t apply because its negligence claim was directed at the services Hoch provided, i.e. the design of the precast concrete components, not how the components were manufactured. Yates pointed out that it was PSI—not Hoch—that manufactured the components at issue. Yates explained that the components themselves were not defective; they all remained as originally erected but “[i]n order to bring the design into compliance with the seismic code, Hoch had to design additional cabling, curbs, and plates to go on top of the existing precast structures.”

The court reasoned that because the nature of Hoch’s role was, “at least potentially, relevant as to whether or not [Hoch] may validly raise the economic loss rule as a defense, the issue would be better decided at the directed verdict stage after the court had viewed the evidence and had a fuller picture regarding the exact nature of Hoch’s role in designing and manufacturing the precast concrete components. The court ultimately did not rule on the issue because the case settled before it reached the directed verdict stage but the court did contemplate the propriety of allowing a design professional to raise the economic loss rule as a defense where a negligence claim is brought against the design professional for its failure to comply with relevant professional standards.

In declining to infer a broad “professional services” exception to the economic loss rule, the court expressed concern that Hoch’s position would distort the rule, which “is intended to strike a balance between encouraging products manufacturers to design their products with care and imposing essentially unlimited liability when they fail to do so.” The court reasoned that in a “more typical” products liability context, the economic loss rule appears to serve the purpose of providing some limitation of damages which a manufacturer might face. For example, “a manufacturer of a car which crashed due to a design defect might conceivably face liability for business losses suffered by individuals who were delayed in traffic following the accident.” Such concerns, the court pointed out, were inapplicable in the instant case because Hoch—unlike the car manufacturer—knew exactly what project they were working on, and it seemed clear that its job was to provide competent professional services in light of that knowledge. In other words, for Hoch and similar defendants, the economic loss is foreseeable.

The court also expressed concern that allowing Hoch to avoid liability under the theory of the economic loss rule would “lead to rather perverse financial incentives.” In the context of this case, the court opined, physical harm resulting from Hoch’s failure to comply with the relevant seismic standards would only occur in the event that an earthquake actually damaged the garage. This would give a contractor in Yates’ position, upon learning of a defect in the engineer’s work, a financial incentive to say nothing in the hopes that an earthquake would not actually occur. Hoch’s argument would leave Yates holding the financial bag for preventively fixing the defects caused by Hoch’s failure to do its job correctly.

As discussed previously, the court ultimately did not rule on this issue. However, the court noted that if it were to fashion the parameters of an exception to the economic loss rule, it would consider whether the economic harm rule serves a useful purpose in cases involving professional services whose core purpose is to produce a product with specified requirements. In closing, the court noted that failing to produce a product that meets those requirements involves “a basic failure to do one’s job correctly and it strikes this court that professionals carry liability insurance for situations such as this.”

Fifth Circuit jurisprudence has already established that the economic loss doctrine does not apply to negligence claims arising out of the performance of services contracts. See Lyndon Property Ins. Co. v. Duke Levy and Associates, LLC, 475 F.3d 268 (5th Cir. 2007) (declining to apply economic loss rule against engineer for costs incurred to fix and test work that had been inspected and approved by engineer); see also Mississippi Phosphates Corp. v. Furnace and Tube Service, Inc., No. 1:07CV1140 LG-RHW, 2008 WL 313770 (S.D. Miss. Feb. 1, 2008) (declining to apply economic loss rule to negligence claims arising out of contract to provide material, labor, and equipment to retube a waste heat boiler). The question faced here, which remains unanswered, is whether the economic loss rule will apply where the core purpose of the services contract is to produce a product that meets specific requirements. In other words, will the fact that the design services are for the manufacturing of a product somehow impact the established jurisprudence?

[1] Hoch had hired Nangia Engineering of Texas, Ltd since it had on staff the required engineer licensed to practice in Mississippi. While Nangia was a party to the case, I only refer to Hoch.

D.C. Court of Appeals Decision Covers Important Contracting PrinciplesThe D.C. Court of Appeals (the Court) recently issued a decision covering some important public construction contract principles, most notably notice, cost and pricing data requirements, and the implied duty of good faith and fair dealing.

The District of Columbia hired a contractor to perform work at the Fort Totten Solid Waste Transfer Facility. The contractor filed claims against the District, seeking compensation for delay costs and change orders. The District of Columbia Contract Appeals Board (CAB) ruled in favor of the contractor. The District appealed and the Court affirmed in part and reversed in part.

30-Day Notice Requirement: The Court noted that recent case law in the District of Columbia interpreting notice requirements in public construction contracts is scarce. The Court adopted the rule, well established by federal courts and federal contract appeals boards, that the notice requirements for claims should be liberally construed and only strictly enforced when the contractor’s failure to give timely notice prejudiced the government. The Court found that there was no prejudice to the District for the contractor’s failure to meet the technical notice requirement because the District was aware of the facts underlying the delay claims and continued to press forward with the contract. Thus, the contractor’s claims were not barred for failing to provide written notice of its claims within the 30-day window.

Cost & Pricing Data Requirements: The Court found that the District’s reliance on a contract provision, requiring the contractor to submit certified “cost or pricing data” before negotiating prices for additional work, was misplaced because the contractor did not bring the claims when costs were prospective. The contract allowed the contractor to submit records of actual costs post-performance when the parties could not reach an agreement on the costs prior to the performance of changed work. The Court also rejected the District’s argument that DC Procurement Rule, 27 DCMR § 1624, requires submission of certified “cost or pricing data” with contract claims.  Rather, it held that 27 DCMR § 3803.2 was the applicable provision, under which the contractor is required to submit “any data or other information in support of the claim.” The contractor submitted its actual cost breakdown, and thus its claims were not barred.

Duty of Good Faith and Fair Dealing: The Court ruled that in every contract there is an implied covenant of good faith and fair dealing applicable to each party and affirmed the CAB’s finding that the District had breached its implied duty of good faith and fair dealing by not fully cooperating with the contractor in obtaining a fire alarm permit. The District failed to respond to the contractor’s request for help and delayed in meeting with the Fire Marshall, which caused a significant delay in obtaining approval of the permit, thus entitling the contractor to damages.

The decision also addresses other important contract issues: the significance of a release in change orders, the implied warranty of design specifications, and the doctrine of patent ambiguity. Read the full decision here.

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New Federal Contracting Requirements for Reporting Tax Liabilities and Felony ConvictionsFederal acquisition officials recently finalized an interim rule intended to remove contractors with federal tax liabilities and felony convictions from the federal contracting arena. The interim rule, which took effect February 26, 2016, was published in December of 2015. No changes were made as a result of the comments submitted before its finalization and effective date of September 30, 2016. The rule amends the FAR by implementing sections of the Consolidated and Further Continuing Appropriations Act of 2015. The purpose of the amendments is to prohibit the federal government from contracting with corporations that have federal tax liability or a federal felony conviction.

Under the rule, offerors responding to federal solicitations are required to represent whether they (1) have a delinquent federal tax liability or (2) were convicted of a federal felony conviction within the preceding 24 months. When an offeror makes an affirmative response in connection with one of these representations, the rule requires the contracting officer to (1) request additional information from the offeror; (2) notify the agency official responsible for initiating debarment or suspension action; and (3) refrain from making an award to the offeror until the agency suspending or debarring official (SDO) has considered suspension or debarment of the offeror and determined that further action is not necessary to protect the interests of the government. If a federal agency has already determined that the disclosed incidents do not require suspension or debarment, the contracting officer may proceed with the award to the offeror without further delay.

The rule imposes additional, more stringent requirements where the offeror proposes a total contract price that will exceed $5 million. The rule states that “[i]f the certification regarding tax matters is applicable, then the contracting officer shall not award any contract in an amount greater than $5,000,000, unless the offeror affirmatively certified in its offer…” that (1) it has filed all required federal tax returns during the three years preceding the certification; (2) it has not been convicted of a criminal offense under the Internal Revenue Code of 1986 (this in addition to the felonies question, and it relates to any offense, including misdemeanors); and (3) it has not, more than 90 days prior to the certification, been notified of any unpaid federal tax assessment for which the liability remains unsatisfied, unless the assessment is the subject of an installment agreement or offer in compromise that has been approved by the IRS and is not in default, or the assessment is the subject of a non-frivolous administrative judicial proceeding.

The rule does not include a time requirement for a reasonable response time for an SDO to make a determination of whether suspension or debarment is required to protect the government’s interests. Despite at least one commenter’s concerns that the absence of a reasonable response time requirement will likely delay the procurement process, no such requirement was added.

It is also noteworthy that the rule contains no de minimis exception. Instead, offerors must disclose all federal tax liabilities. The rule does allow offerors to hold off on reporting tax debts until all appeals are exhausted. However, offerors must report any federal felony conviction, regardless of whether the conviction is on appeal.

The rule applies not only to C corporations, but also to entities such as S corps, professional corporations, LLCs, and may also apply to partnerships and joint ventures. In the response to a comment asking for clarification of the meaning of “corporation,” the agencies wrote: “A corporation is a legal entity that is separate and distinct from the entities that own, manage, or control it. It is organized and incorporated under the jurisdictional authority of a governmental body, such as a state or the District of Columbia.”

While no substantive changes were made to the interim rule, the finalization of the rule nonetheless is noteworthy because it will likely result in an increased government focus on and scrutiny of contractor certifications regarding delinquent tax liability and federal felony convictions. Accordingly, contractors should be particularly vigilant about ensuring the accuracy of federal certifications, as the penalties for making a false certification to the government can be many and severe.

For a related article written by Aron C. Beezley analyzing the interim rule, see Inside New FAR Provisions on Reporting Felony, Tax Info.

View the Federal Register announcement finalizing the interim rule published at 81 Fed. Reg. 67728-67731 (September 30, 2016) here.

View the interim rule published at 80 Fed. Reg. 75903-75907 (December 4, 2015) here.

View the Consolidated and Further Continuing Appropriations Act here. (The new rule implements sections 744 and 745 of Division E and section 523 of Division B).

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