Mechanic Liens and Payment Disputes Lead to Construction Defect Litigation

Here at The South Carolina Construction Defect Blog, I have decided to discuss a recent trend that has had a direct bearing on my construction defect practice at Olson Good & Brown. While this is probably not a brand new phenomenen, I do believe that the economy is a contributing factor in construction defect suits.

Take the hypothetical situaion as follows: Owner contracts with Builder for construction of a custom built home for $500,000.00. This is a cost plus job which is negotiated based on $400,000.00 worth of expenses plus 25%. The lot has been owned for one year by the owner prior to contracting with Builder. Because the lot is owned by the Owner, construction financing is provided by a local lender pursuant to the following terms:

$500,000.00 to be delivered in 10 draws of $48,000.00 each, with the owner bringing $20,000.00 cash to the construction loan closing. The lot has appreciated in the past year, and there is no reason to think that the improvements to real property will appraise for anything less than $725,000.00 once construction is complete.

The plans submitted to the lender during the construction loan process were purchased from a local supply company, and they bear a seal which does not allow for the transfer of the plans without consent of the architect. The bank does not require that the owner employ architectural supervision. Further, the contract between Owner and Contractor is not an AIA or AGC document and, therefore, provisions regarding change orders and approvals are somewhat unclear.

There are several change orders along the way which push construction costs to $470,000.00, which leaves the builder $70,000.00 short of his original profit based on the $400,000.00 model and, the builder further argues that upon the final draw being applied to materials that he is actually entitled to cost plus 25% of $470,000.00, which equates to a contractor fee of $112,500.00, leaving the builder short by at least $70,000.00 and arguably $82,500.00. Because the home is substantial complete, the lender is not willing to contribute additional funds to the contractor due to the fact that its collateral (HOME and LOT) are complete, as well as loan to value issues which have worsened since the loan was approved over twelve months ago. Unable to collect, the buidler files a mechanic’s lien within 90 days of the completion of the work in the county where such work was performed. S.C. Code Ann. Section 29-5-90. After further negotiations fail, the builder files suit within six months of the last day he provided services on the Owners land.

As the owner is now attempting to obtain more suitable financing, the mechanic’s lien foreclosure action prevents the delivery of marketable title as collateral for the loan he is seeking. Further, the property appraises at $620,000.00 due to economic conditions, which make the prospect of a conforming loan even more challenging. As the Owner is frustrated, and almost thirty (30) days from responding to the Complaint, he hires an attorney who prepares an Answer, as well as a counterclaim for slander of title. The case goes on the trial docket approximately eight months later, and discovery has yielded several declining appraisals, and a finger pointing contest as to whether or not the change orders were agreed upon.

Thirteen months following substantial completion, and several months into the payment lawsuit, the Owner begins to fear that his roof has been installed in a deficient manner as a high wind event and ensuing thunderstorm reveal some evidence of water in the attic. It is not clear the source of the water, as there is some HVAC equipment which is adjacent to the area of condensation. The owner is irrate as the home warranty he purchased has expired twelve days beforehand, and his hazard insurance company denies the claim he makes on the basis that the high wind event did not reach a critical or dangerous level. The brief inspection which was performed by the homeowners insurance representative yields a two page declination which states that “condensation is more likely attributable to heavy cycling and moisture being produced by the HVAC unit which is oversized per the house layout.” The Owner fails to tell the inspector that the entire upstairs was altered at his wife’s request as she is expecting a child. The alteration caused the builder to correctly specify a larger unit than was specified on the stock plans. The inspector’s report further states that the moisture might be resulting from “inadequate roofing”, although is not conclusory due to the fact the inspector is not a licensed conractor, engineer, or other building professional.

The Owner consults with his attorney who advises that he amend the suit to file a counterclaim alleging construction defects. Because these alleged defects were latent in nature, the Court allows these to be brought and not barred by any statute or legal theory. When the contractor receives a copy of the suit papers, he provides copies to his attorney who tenders the construction defect claim to the builder’s insurance agent who, according to proper protocol, tenders the suit papers to the CGL carriers from the policy year in which the home was completed, as well as another carrier who assumed coverage for the next policy period.

The insurance company seeks a coverage opinion and the defense is assumed based upon South Carolina courts relying on the “four corners” of the Complaint. “A liability insurer must defend any suit alleging bodily injury or property damage seeking damages payable under the terms of the policy.” B.L.G. Enters., Inc, 334 S.C. at 535, 514 S.E.2d at 330. So long as the allegations made in the Complaint assert a covered claim, CGL policies will offer a defense which is completely separate and distinct from its duty to actually indemnify.

(EDITOR’S NOTE Although the cases addressing an insurer’s duty to defend generally limit this duty to whether the allegations in a Complaint are sufficient to bring the claims within the coverage of an insurance policy, an insurer’s duty to defend is not strictly controlled by the allegations in Complaint. Instead, the duty to defend may also be determined by facts outside of the complaint that are known by the insurer. See BP Oil Co. v. Federated Mut. Ins. Co., 329 S.C. 631, 638, 496 S.E.2d 35, 39 (Ct. App. 1998) (“Although the determination of an insurer’s duty to defend is based upon the allegations in a complaint . . . in some jurisdictions, the duty to defend will be measured by facts outside of the complaint that are known by the insurer.”)

As no compelling information was known to the insurer, a prominent law firm is hired to defend the matter under a reservation of rights. After the appearance is made on behalf of the Builder for the construction defect allegations, several depositions, motions, and an eventual mediation yield the following result:

Builder is Successful in Proving that $60,000.00 was owed to him, although his foreclosure proceding was halted short when it became apparent that the home’s value did not have enough equity to be purchased at the Master in Equity auction for more than the priority mortgage loan amounts. The Builder accepted a confesssion of judgment in the amount of $80,000.00, which took into account his attorneys fees. The judgment has still not reaped any rewards, as the Owner only received $4200.00 in nuissance money as it could not be proven that the condensation was attributable to any breaches of contract, duty, or negligence on the part of the buidler or its subcontractors.

The Builder’s insurance company contributed $41,000.00 to the law firm defending the frivilous defect suit and $8500.00 in expenses for the retention of experts and other costs. All in all, roughly $50,000.00 was spent to defend a frivilously brought retalliatory counterclaim. At the end of the year, the Builder was forced to locate another insurance carrier as future coverage was declined due to an increase in overall claims made.

Is there anything to learn from this lesson in economic waste? I am not really sure. The Builder did his job and deserved to be paid for it. The Owner of the home probably intended to pay for items which he could not afford once the construction loan was exhausted per change orders. The attorney for the Owner would likely not be subject to sanctions if he could show reliance was justified on the hazard insurance carriers report which attributed the condensation to either the HVAC or the Roof installation. The Builder’s liability carrier did its job by indemnifying and protecting its policyhodler. While the defense attorneys might have made a true attempt to avoid the suit by making a suggestion to settle prior to full blown discovery costs being eaten up, it likely would not have yielded an early settlement. The fact of the matter is, no singular party could be labeled a bad actor, yet it is certain that each party contributed to the economic waste which was produced in this situation.

1) Professional AIA or AGC style contracts might be bulky and perceived to be “unnecessary” for residential construction, although it is hard to argue that these contracts do not do their job in defining ambiguities lying within project administration and delivery such as the dreaded change order.

2) Owners need to be careful and stay within budget as economic uncertainties have caused credit markets to shrink. Equity is not guaranteed, and buyers need to beware when asking for items that are outside of the cost plus agreement or plans that they provided to the Builder.

3) Insurance carriers might hold the key in forcing contractors to employ project administration and delivery methods which are more efficient, and fully documented. While the issue of contractor payment is typically thought of to be a risk allocated to the bond market, this lengthy fact pattern shows just the opposite.

There is no conclusory answer or lesson to be learned other than we all need to become more efficient in our practices. Whether we are a consumer borrowing money for a custom home, a Builder trying to please, or a lawyer stuck in the middle. There needs to be some sort of way to address these needless defect cases which don’t even involve construction defects at all.


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