While the benefits of owning and operating green certified buildings are often discussed, the legal implications of their design and construction can be overlooked. Clear-eyed owners should weigh some practical considerations before entering into design or construction agreements aimed at green certification. Here are five factors you should discuss with your construction lawyer about your next green project.
1. Costs of Navigating Sustainability Certification
The number of U.S. counties instituting green building programs has risen by 500 percent since 2003, according to an AIA study. More than 44 states and 100 municipalities have green building laws, according to the USGBC. In fact, localities are so eager to put green building laws on the books that some may be doing so in conflict with existing laws – or without a comprehensive understanding of the issues they want to regulate.
Conflict can arise when a municipality, county, or state is pre-empted by federal law from instituting certain regulations. For example, Albuquerque, NM, passed high-performance HVAC requirements in 2007 that violated the Energy Policy and Conservation Act of 1975 (EPCA). With some limited exceptions, the EPCA prohibits any such local HVAC law related to the energy efficiency, energy use, or water use of any covered product. When the City of Albuquerque was sued by the Air Conditioning, Heating, and Refrigeration Institute, the court ruled that the city was enjoined from prescribing such HVAC regulations by federal law.
Eagerness to pass green building regulations may also result in confusion. For instance, the Washington, D.C., Green Building Act requires the issuance of a performance bond to guarantee that private projects attain LEED and qualify for financial incentives from the city’s Green Building Fund. However, no bonds exist in the surety market that would come close to ensuring certification by a third party. By enacting this piece of legislation, the city council imposed an impossible requirement to qualify for its incentives.
Bottom Line: Make sure your legal budget is adequate to assess sustainability requirements and regulations in your jurisdiction.
2. Standard of Care and Professional Liability Coverage
Reputable architects and engineers maintain professional liability policies that cover their liability from negligent performance. Negligence occurs when a design professional fails to perform in ways consistent with the "standard of care."
A design professional’s liability policy covers negligent errors and omissions (i.e. deviations from the standard of care). Contractual agreements that require the architect to exceed, or in some way perform beyond, the standard of care may carry designers right out of their liability coverage. For example, warranties or guaranties issued by designers to owners aren’t typically insurable under professional liability policies.
It’s possible that engaging a design professional, particularly if the designer is a LEED AP, could elevate the scope of the services beyond the applicable standard of care. That might imperil the designer’s liability coverage and greatly diminish the designer’s ability to compensate the owner.
Bottom Line: Consider professional liability coverage issues and applicable standard of care. Discuss coverage scope with your designers and their risk management representatives.
3. Cost Control and Potential Overruns
Unless appropriate controls are established early, possible cost overruns are an intrinsic risk. The hard costs are often higher than those of traditional construction due to technology and equipment. Adjustments to ensure green certification can result in legitimate change orders. At bid time, cost overruns can result in delays and expenses for value engineering and, in the worst case, force project cancellation. It’s a given that cost overruns during construction result in disagreements and possible legal disputes.
Owners who are concerned about controlling these risks should engage a green building cost consultant for cost estimates, budgets, technical input on construction methods, and scheduling know-how. This consultant should be a contractor who is experienced with the type of green building contemplated for the project.
Bottom Line: Consider engaging a qualified consultant.
4. Waiver of Consequential Damages and Other Contractual Provisions
The vast majority of U.S. design and construction agreements are based on form agreements published by professional societies and contractor trade groups. While these documents are sophisticated in scope, they’re often unbalanced with respect to the interests of owners who sign them. An excellent example of this bias is the "mutual" waiver of consequential damage provisions, which are commonly found in these agreements.
In most states, parties to a contract are liable for losses arising from a breach of the agreement that’s reasonably within their contemplation when they enter into the agreement. This rule applies to direct and consequential losses resulting from a breach of contract. These mutual damage waivers limit the parties’ rights to recover such damages; the waivers are limitations of liability, which transfer risk from designers and builders to their owner clients. Owners should use extreme caution in accepting them – tax credits and marketing considerations could be adversely affected by certification failure. Owners with green projects should be prepared to object and oppose the waivers.
To prepare for a negotiation concerning the inclusion of a damage waiver, bear in mind:
- The risk and severity of damages waived by the parties aren’t mutual, and the clause favors designers and contractors.
- The term "consequential damages" is ambiguous and not clearly defined.
- The waiver allocates risk to the party least able to manage or mitigate risk.
- The waiver prevents fair compensation to owners.
- The waiver limits owners’ rights to recover damages and defeats the purpose, at least in part, of designers’ or contractors’ obligation to purchase insurance.
Bottom Line: Accepting any significant waiver of damages doesn’t make sense.
5. Economic Loss Rule
While very little litigation has yet occurred, commentators suggest that risks abound with green construction, including financial losses due to a new category of claimed construction defects, such as a project’s failure to obtain LEED certification, or higher-than-expected operation and maintenance costs.
Owners assume that contractors and subcontractors should be liable for these kinds of damage, but that assumption may not be correct if the project is in a state that applies the "economic loss rule." This rule means that a party whose claim is based upon a financial loss caused by a construction defect is entitled only to recovery from parties contractually responsible for preventing the defect. To the extent that the economic loss rule applies, it may prevent owners from suing the responsible subcontractor or design consultant for financial losses due to a green defect, unless the applicable subcontract provides otherwise.
Owners concerned about the economic loss rule in conventional projects typically require contract features obligating contractors and subcontractors to construct in accordance with the plans and warranty work against defects. Owners should be named as an "intended beneficiary" of the subcontracts with the right to directly sue the subcontractor for breach of construction warranties.
Green building adds a new dimension to the economic loss rule. It remains to be seen whether courts will consider failure to obtain LEED certification, or failure to reach anticipated operation and design cost savings, a construction defect. To avoid disputes and maximize the ability to recover in a state with the economic loss rule, owners should negotiate text in the prime contract addressing the extent to which the contractor will be responsible under its warranties, and those given by the subcontractors, if the building isn’t as green as anticipated.
Bottom Line: During the contract drafting stage, address the negative consequences of the economic loss rule in the law of your jurisdiction. Ensure that you can pursue responsible parties, regardless of your contractual position.
Christopher S. Dunn is a partner at Waller Lansden Dortch & Davis LLP in Nashville, TN. John E. Kofron is a shareholder and director of Phoenix-based Fennemore Craig, PC, where he chairs the firm’s Construction Law Group. The authors thank Lianne Childress, an associate with Waller Lansden Dortch & Davis, for her contribution to this article.