Legal Aspects of Design Build: What Recent Cases Tell Us

The design-build “boom” started about a decade ago, as public and private sector owners looked for an alternative to design-bid-build and construction management delivery approaches. While its widespread adoption was influenced by a variety of factors, almost all of design-build’s benefits can be attributed to the one attribute that differentiates it from every other delivery system-it is a truly integrated project delivery system where the designer and contractor have contracts directly with each other, not separately with the owner.

This direct contractual relationship enhances the ability to phase design, procurement and construction activities and to accelerate project completion. It makes for a better atmosphere on the project, with the designer and contractor having a commercial need to cooperate with each other. It can promote innovation, as the designer has a contractor working with the project directly during design development, as contrasted with having an unknown, low bidder interpreting its completed design. It also gives the owner an important contractual benefit, called “single point of responsibility.” If the procurement and contracting is done right, the owner can take itself out of the middle of most claims arising from design and construction problems.

While it is clear that all parties can benefit greatly from tying the contractor and designer together by contract, the law has been struggling to keep pace with the dynamics created by this relatively new relationship. Beginning in 1995, I began a yearly process of chronicling and analyzing the universe of design-build caselaw in a publication entitled Design-Build Lessons Learned. The ten editions of Design-Build Lessons Learned published from 1995-2004 reviewed approximately 350 cases from around the country with issues ranging from unique design-build issues to “garden variety” construction disputes like default terminations and delay claims. Of the many lessons learned from these cases, three unique design-build issues stand out most prominently.

Single-Point-of-Responsibility Obligations are 
Routinely Upheld by the Courts

The single point of responsibility aspect of design-build has been reviewed by a number of courts over the past ten years, and with very few exceptions, the litigation results have been disastrous for design-builders trying to argue their way out of liability. Design-builders have been held accountable for the following, among other things: 

1. liquidated damages for failing to meet performance guarantees, in spite of enormous cost consequences to the 
   design-build team 
2. consequential damages, sometimes resulting in the design-builder having to “buy back” the entire project from the owner
3. the problems of their subcontractors who directly cause the problem, even when the subcontractor has been separately sued by the owner

Readers should note that the caselaw enforcing the design-builder’s obligations to meet its design and construction responsibility arises not only on industrial facilities (where performance guarantees are routinely used), but also on commercial and residential buildings.

The contract risk imposed by this single point of responsibility design-build feature is so strong that courts have even found liability when performance is commercially impracticable (i.e., it costs a ton of money to fulfill the design-build contract). A fascinating case released in late 2004, Lockheed Martin Idaho Technologies Co. v. EG&G Idaho Inc., involved a turnkey environmental remediation contract that contained a number of performance specifications and guarantees. 

Although it spent substantial money and time trying, the turnkey contractor was never able to meet its contractual obligations and was ultimately terminated for default. Among its primary defenses was that the cost of meeting the specifications was so high, (by some measures over $100 million more than the base contract price) that its lack of performance should be excused on the basis of commercial impossibility. The court flatly rejected all of the contractor’s excuses, citing to the turnkey contract and the fact that the contractor assumed the risk of performance. Among other things, the contractor was required to return all of the money it had been paid under its contract – over $50 million!

Owners Bear Responsibility for Errors in 
Their Bidding Documents

One major legal question repeatedly arises relative to design-build: who bears responsibility for problems arising out of the design furnished by the owner during the bidding process? Most owners take the position that their design is preliminary, it should not be relied upon, and that the design-builder, as the designer-of-record, bears these risks. As expected, most design-builders take issue with this approach, arguing that they have the right to rely upon the accuracy of what the owner puts into the bidding package, and if there are mistakes in the owner’s preliminary design, the design-builder should be paid extra to correct those mistakes.

Only a handful of cases have addressed this issue and virtually all have sided with the design-builder’s view that the owner should bear the risk of defects in their documents. Part of this is based on equitable principles, as courts have found it unfair to require a design-builder to spend significant monies in the bidding stage to figure out an owner’s design errors. Part of this is based on a “with control comes responsibility” type of thinking. Courts conclude that owners who decide to use detailed design specifications as part of their bidding package have to do their work correctly and cannot assume that a competitive bidder will assume all risks just because it has a contract to finish the design.

One of the most recent cases, Donahue Electric, Inc., clearly explained why the owner bears these risks. The issue in Donahue Electric involved problems that resulted when a boiler prescribed by the government in the bidding documents turned out to be undersized and could not properly operate a piece of government-furnished equipment. The Veterans Administration argued that the design-builder was obligated to properly size the boiler and could not rely on the bidding documents. The Board of Contract Appeals disagreed, stating:

“Specifications included in a design/build contract, however, to the extent specific requirements, quantities and sizes are set forth in those specifications, place the risk of design deficiencies on the owner.  Thus, the VA reassumed the risk and warranted the accuracy of the specifications with regard to the [boiler that it specified].”

Unfortunately, as many readers undoubtedly know, there are too many owners who still have a philosophy of trying to shift this risk to the design-build team, even though they should know that this creates bidding uncertainty (i.e., higher bid prices) and potential claims.

Designers Have Major Exposure to Contractors for 
Mistakes during the Proposal Process

Designers have been struggling to understand their exposures to contractors on design-build projects. While the caselaw has been somewhat limited, it appears that designers will be on the “short end of the stick” in conflicts with their new “client,” the general contractor.

A 1996 case, C.l. Maddox, Inc. v. Benham Group, Inc., remains the seminal case in this area and involved the construction of a coal processing system for an electric power plant. Maddox, a general contractor, entered into an oral agreement with Benham, an engineering firm, whereby Benham was to prepare drawings, specifications and equipment information to enable Maddox to prepare a lump sum construction proposal to the owner for the project. Relying heavily upon the quantity estimates prepared by Benham, Maddox was ultimately awarded the design-build contract, which then led Maddox and Benham to enter into their own written agreement for design services.

The relationship was rocky from the start. Maddox claimed problems with Benham’s performance, including the fact that the drawings were often late and insufficient, that Benham had underestimated the amount of work needed to complete the final design and that because prints for the electrical components of the project were not available, Maddox ended up having to install part of the wiring without plans. Maddox successfully convinced the jury to award over $5 million in damages, including over $2.7 million for bidding errors, engineering errors and delays caused by Benham.

Benham appealed the jury’s verdict, arguing among other things that the oral contract for proposal services was not enforceable since the written contract’s integration clause superseded “prior negotiations, representations or agreements.” The appellate court disagreed, finding that the oral contract for preliminary bidding was a wholly separate and independent contract that was bargained and paid for by Maddox with full performance having been completed by Benham. The court also found that Benham had impliedly warranted the accuracy of the bidding information by repeatedly assuring Maddox and the owner that it had the expertise and manpower to perform and do the work.

Other courts have issued decisions similar to Maddox, and there tell the industry that designers need to be smart and proactive in their contracting relationships with contractors. However, this is still an evolving area, as can be seen from an interesting dispute brewing in New York on a design-build bus depot for New York City Transit Authority that has already resulted in some reported decisions. One of these decisions, Metropolitan Steel Industries, Inc. v. Perini Corp., discussed a three-way dispute among the design-builder, steel erection trade subcontractor and design-builder’s engineer. The design-builder claimed that the business was damaged by the engineer’s deficient design work, both pre-bid and after contract award and sought, among other things, for the engineer to indemnify the business for any losses.

The New York Superior Court dismissed many of the claims brought by the design-builder against the engineer.It disagreed that the indemnity clause provided absolute protection for claims by trade subcontractors, finding that the design-builder was too actively involved in the design process and directing the trade subcontractor to take advantage of an indemnity. Contrary to Maddox, this court rejected the idea that there was a binding oral contract between the design-builder and engineer for pre-proposal services that would create liability for the engineer.

A host of other conclusions can be drawn from recent design-build caselaw. Too many cases involve disputes over the “business deal” among the design-build team, reflecting a failure of all parties to get a clear contract in place early in the process-particularly for proposal-related services. Courts have been routinely enforcing copyright interests, much to the surprise and dismay of those who mistakenly think that by paying a design-build fee they have the right to use design creations any way they would like. Public sector design-build litigation is growing very fast, largely because of the failure of public agencies to understand how to procure and administer an integrated design and construction contract. Those of you who are actively in the design-build market need to keep your eye on these trends-a lot of these legal issues remain in search of an answer.

Construction Business Owner, March 2006