Hinshaw's Construction Law Update is provided to our clients and contacts in the construction and design industries to keep you informed of significant legal issues and cases. You may click on the article headings below to read the entire content on our Web site and to find the contact information of Hinshaw construction law attorneys who will answer any questions you may have. If you have any comments or suggestions, please contact the editors, Timothy A. Hickey or Timothy G. Shelton.In This Issue:
Illinois Appellate Court Reaffirms Economic Loss Doctrine
In a lawsuit against an architect represented by Hinshaw & Culbertson LLP’s Chicago office, the Illinois Court of Appeals held that owners of a “luxury home” could not sue the architectural firm for negligence. The owners’ remedy, if any, existed under contract, not tort law. The owners did not sufficiently allege that a contract existed between them and the architect. The Court confirmed the trial court’s dismissal of the action. Martusciello v. JDS Homes, Inc., et al., Illinois Appellate Court, First District, 1-04-1495. The Court’s opinion, released September 26, 2005, reinforced Illinois law barring recovery of economic damages under a negligence theory against an architect.
The Martusciellos pursued a negligence theory against the architect and his architectural firm for alleged deficiencies in his design of their “luxury home.” The plaintiffs claimed that the design lacked detail such that the contractor had to “fill in the blanks” to construct the home. Allegedly, the contractor improperly did so, creating defects in the windows and causing significant leakage, crumbling materials, and defects in the stairs and decks.
On appeal, the plaintiffs argued that a negligence theory against an architect is viable if no contract exists between the owner and architect. Alternatively, the plaintiffs sought to allege a breach of contract theory, attaching a signed letter from the architect regarding services to be performed and certain invoices prepared by the architect to support the contract claim. The plaintiffs cited an Illinois case, Congregation of the Passion v. Touche Ross & Co., 159 Ill.2d 137, 636 N.E.2d 503 (1994), in support of their argument that one can seek economic losses against an architect under a tort theory when no contract exists between the parties. The Appellate Court disagreed. Congregation of the Passion permitted a negligence claim against an accountant, not an architect.
The Martusciello court noted that accountants, like attorneys, provide services that cannot be completely memorialized into contract terms, which create exceptions to the economic loss doctrine. In those services, the result of the relationship between the professional (accountant or attorney) and client is something intangible. This relationship is distinguished from professional relationships that produce tangible services, such as an architect-client relationship. The court would not attach liability to the architect independent of a contract. Since an architect produces what Illinois courts consider a “tangible result,” such as a blueprint or plan that results in a structure, the economic loss doctrine applies to bar negligence claims against a design professional.
The Martusciello court also determined that the plaintiffs could not maintain a breach of contract theory against the architect. The court remarked that the plaintiffs could have specified the level of detail to be incorporated into the design of their home through the contract. According to the record, they chose not to do so and, as a result, must suffer the consequences. The opinion echoes existing Illinois law that, “[a] plaintiff seeking to recover purely economic losses due to defeated expectations of a commercial bargain cannot recover in tort, regardless of the plaintiff’s inability to recover under an action in contract.” Anderson Electric, Inc. v. Ledbetter Erection Corp., 115 Ill.2d 146, 153, 503 N.E.2d 246 (1986).
The Martusciello court barred the plaintiffs’ claim against the architectural firm for the same reasons. Plaintiffs may not seek purely economic losses due to defeated expectations of a commercial bargain from an architect or engineer in tort.
The court also made short shrift of the plaintiffs’ argument that the trial court erred in not permitting them to file a breach of contract claim along with their motion to reconsider the court’s dismissal of their case. The court first reiterated traditional contract law that only a duty imposed by the terms of the contract can give rise to a breach and that a plaintiff must allege, among other things, definite and certain terms of the party’s agreement. Romanek v. Connolly, 324 Ill.App.3d 393, 404, 753 N.E.2d 1062 (1st Dist. 2001). The court held that the plaintiffs failed to allege facts sufficient to support a breach of contract claim.
The Martusciello court noted that the architect’s proposal and invoices that the plaintiffs attached to their proposed amended complaint, did not provide sufficient terms to show the scope of agreement; or more importantly, that the architect agreed to prepare detailed plans for their home. The Court affirmed the trial judge’s dismissal with prejudice of the plaintiffs’ complaint and proposed amended complaint.
This opinion is a significant victory for the members of Hinshaw’s Construction Law Group and received front page coverage from the highly respected Chicago Daily Law Bulletin.Arizona Begins to Turn the Tide and Favor Contractual Arbitration Provisions
Home builders, their insurers and home warranty companies all appreciate the expenses associated with litigation. In an attempt to limit those expenses and avoid the time and expense associated with court-based litigation, contracts have been designed to include arbitration clauses requiring home buyers to proceed to arbitration. Home buyers seem to have little problem accepting the arbitration clauses at the time of purchase. It is only when they realize the limitations of arbitration that they are likely to object.
Arbitration is favored as public policy under both federal and state law. The federal statement of public policy is embodied in the Federal Arbitration Act (9 U.S.C. § 1 et seq.) Arizona courts have determined that it is a reversible error to deny enforcement of a contract under the Federal Act. Rocz v Drexel, Burnham, Lambert, Inc., 154 Ariz. 462, 743 P. 2d 971 (App. 1987).
Additionally, Arizona has stated public policy in favor of arbitration in its own Arbitration Act, A.R.S. §12-1501, which provides:
"A written agreement to submit any existing controversy to arbitration or a provision in a written contract to submit to arbitration any controversy thereafter arising between the parties is valid, enforceable and irrevocable, save upon such grounds as exist at law or in equity for the revocation of any contract."
Given the public policy favoring arbitration, it seems reasonable to expect that if an arbitration clause is in place, disputes arising under a home sale contract or home warranty will simply proceed to arbitration. This has not proven to be the case.
Homeowners’ attorneys have avoided the arbitration provisions by claiming that the arbitration clause is a part of a “contract of adhesion.” While seeking the benefits of the contract, the homeowners claim that it was presented as a “take it or leave it” proposition with no realistic opportunity to bargain for the terms. The contract, they argue, is nothing more than a standardized or boilerplate document with one-sided terms. The homeowners further claim that the arbitration clause was never explained to them and that they never realized they were waiving their rights to a jury.
Courts apply Arizona’s “reasonable expectations” doctrine when analyzing the contracts, which further complicates matters and can result in the arbitration clause being declared invalid. Under this doctrine a term in an agreement is invalid if one party to the agreement (in this case the home builder or home warrantor) had “reason to believe” that the other party (in this case the homeowner) would not have accepted the agreement had he or she known the agreement contained that particular term.
“Reason to believe” may be (1) shown by the prior negotiations of the parties; (2) inferred from the circumstances; (3) inferred from the fact that the term is bizarre or oppressive; (4) proved because the term eviscerates the non-standard terms explicitly agreed to; or (5) proved if the term eliminates the dominant purpose of the transaction. The doctrine of reasonable expectations also requires drafting of provisions that can be understood if the customer does attempt to check on his rights. Finally, courts must consider any other facts relevant to the issue of what a party reasonably expects from the contract.
In application, Arizona courts have used the reasonable expectations doctrine to consider whether certain homeowner “complaints” justify striking the arbitration — complaints, for example, that the arbitration clause was never read or seen or that it would never have been agreed to if the homeowner had known it would limit the opportunity to seek remedies in court or to be heard by a jury. The courts often further justify a decision to strike the arbitration clause by noting that the clause requires the homeowner to initiate the arbitration proceeding within a limited period of time and to pay the associated filing fees to a specific arbitration provider. The fees, which are usually much greater than those associated with filing a lawsuit, allow the court to declare the clause unconscionable.
As a result of the courts’ application of the reasonable expectations doctrine and attention to the homeowners’ “complaints,” Arizona homeowners often avoid arbitration and proceed to court despite the overwhelming public policy in favor of arbitration.
A new appellate court decision stands to reverse the trend against arbitration. In Harrington v. Pulte Home Corp., 211 Ariz. 241, 119 P. 3d 1044 (App. 2005), the Arizona Court of Appeals held that the reasonable expectations doctrine did not prohibit enforceability of a specific arbitration clause and that arbitration clauses in general are not substantively unconscionable.
The Harrington court began its discussion by acknowledging the strong state and federal policy favoring arbitration. The court then addressed various factors associated with the doctrine of reasonable expectations and rejected the standard complaints. First, the court determined that the arbitration clause was not “bizarre or oppressive,” reiterating that arbitration is favored by public policy. Next, the court found that the presence of an arbitration clause did not eviscerate the non-standard terms of the contract at issue. Further, the court concluded that the dominant purpose of the contract—the purchase of a house—was not undercut by the presence of an arbitration clause. As to whether the arbitration clause could be understood, the Harrington court noted that the clause at issue specifically incorporated the AAA construction arbitration rules and that the homeowner could simply refer to AAA rules to address any concerns regarding their rights. Finding the other “reason to believe” factors irrelevant to the case before it, the Harrington court concluded that the reasonable expectations doctrine did not prohibit the enforcement of the arbitration clause.
The Harrington court then considered whether the right to a jury must be conspicuously waived. Citing federal case law, the court declared: “Common sense dictates that we reject this argument. The loss of the right to a jury trial is a necessary and fairly obvious consequence of an agreement to arbitrate.” 119 P.3d at 1052 (citations omitted). The court concluded that the arbitration clause itself is an effective statement that a right to a jury trial will not be afforded.
Finally, the court addressed the issue of substantive unconscionability. Factors to be considered when determining unconscionability include: (1) whether the terms are so one-sided so as to oppress or to result in unfair surprise to an innocent party; (2) whether an overall imbalance in the obligations and rights is imposed by the bargain; and (3) whether a significant cost-price disparity exists. As to the last factor, the court explained that the primary purpose of arbitration in Arizona is to provide an inexpensive and final disposition of disputes and an alternative to litigation.
The Harrington court concluded that the homeowners had not met their burden of proving the arbitration clause to be substantively unconscionable. Primarily, they failed to prove that the AAA arbitration costs were prohibitively expensive. They also did not show that arbitration would put them in a worse position than litigation, or that enforcement of the arbitration clause would “oppress or unfairly surprise” them or result in “an overall imbalance in the obligations and rights imposed by the bargain.” 110 P.3d at 1056 (citation omitted).
Having concluded that the arbitration clause was enforceable, the Harrington court remanded the matter for further proceedings.
The importance of this case is that the standard excuses for routinely striking down arbitration clauses may no longer carry the same weight. While the courts are still required to conduct an individual analysis of each contract and the appropriate factors, the public policy favoring arbitration will not be so lightly disregarded.
It should be particularly noted, however, that the Harrington decision leaves room for argument in other cases where the arbitration provider’s costs are prohibitively expensive. Accordingly, Arizona home builders and home warrantors should review their arbitration clauses with an eye toward precluding cost-based arguments. This effort could go a long way in helping to reverse the current trend against arbitration.Contact for more information: Darrell S. DudzikRecent Changes in Illinois LawDesign Build Legislation for CDBSenate Bill 766, which passed in the Illinois Senate in the Spring and in the House on November 3, 2005, and is currently awaiting the Governor’s signature, would authorize the Illinois Capital Development Board (CDB) to utilize design-build contracting procedures. The bill calls for a two-phase selection process in which two to six finalists are selected in the first phase for a short list based on qualifications. The second phase is a technical and cost evaluation phase in which the total project cost criteria is weighted at 25 percent and other factors account for the remaining 75 percent. Since the bill passed the House by a vote of 106 in favor and nine opposed, and passed the Senate by a 51-2 margin, with the support of CDB, it is anticipated that Governor Blagojevich will sign the bill into law in the next 60 days. Concrete Crushing and Recycling Facilities and Use of Clean Construction Demolition Debris as FillThe Illinois Environmental Protection Agency had taken the position recently that if construction with protruding rebar was delivered to a concrete crushing and recycling facility, a permit for a waste transfer or treatment facility was required even though the facility separated the rebar from the concrete and recycled both. Public Act 94-272, which was signed into law effective July 19, 2005, amended the Illinois Environmental Protection Act to clarify that uncontaminated clean concrete with protruding rebar is considered clean construction or demolition debris, not waste, and it does not require a permit if it is recycled within four years of its generation, is not speculatively accumulated and, if used as fill, is used in accordance with the restrictions on the use of clean construction or demolition debris or fill.Public Act 94-272 also amended the Act to require regulation of the use of clean construction or demolition debris as fill material in current or former quarries, mines or other excavations. As of August 16, 2005, anyone seeking to use clean construction or demolition debris at a current or former quarry, mine or other excavation must apply for an interim authorization from the Illinois Environmental Protection Agency. The Act also sets forth a schedule to eventually require permits for all such fill operations by July 1, 2008. The Act exempts from its interim authorization and permit requirements: (1) use of fill material on sites where the clean construction or demolition debris was generated; or (2) use in an excavation other than a current or former quarry or mine if the use complies with Illinois Department of Transportation specifications.Thus, use of broken concrete as fill at a building site now requires IEPA approval unless the concrete came from the site or the site has been approved in accordance with IDOT road contract specifications. New Prompt Payment Act Hearing ProceduresPublic Act 94-672, which takes effect January 1, 2006, amends the Prompt Payment Act to provide greater protection to subcontractors. The amendments provide that if a contractor, without reasonable cause, fails to make full payment to a subcontractor for work that is paid by the State to the contractor, the subcontractor may provide written notice to the relevant State agency. That agency must then appoint an administrative law judge and hold a hearing within 15 days of receipt of the written notice from the subcontractor. If the administrative law judge finds that the contractor failed to make payment in full without reasonable cause, it must notify the contractor of its finding and the amount owed plus interest. If the contractor fails to make the required payment within 15 days of the administrative law judge’s finding, the contractor is to be barred from entering into a State construction contract for a period of one year. Certified PayrollsPublic Act 94-515 that became law August 10, 2005, amended the Illinois Prevailing Wage Act and made some rather significant changes to the information required in certified payrolls that must be submitted on Illinois public work projects. Among others, the changes would require certified payrolls to include the employee’s job classification or classifications and the number of hours worked each day. Due to the significant customized changes that the Act would require to employers’ accounting systems, the Illinois Department of Labor verbally agreed not to enforce the law to give various contracting organizations an opportunity to pass corrective amendatory language. Although this effort failed in the Fall veto session, the uneasy truce apparently has been extended to allow for amendatory efforts in the Spring.Contact for more information: Edward R. Gower
This newsletter has been prepared by Hinshaw & Culbertson LLP to provide information on recent legal developments of interest to our readers. It is not intended to provide legal advice for a specific situation or to create an attorney-client relationship.