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Extended Duration Warranties, Performance Warranties, and

Liquidated Damages in Construction Contracts – What are the Risks?

Presented by:

Gene Rash & Rolly Chambers

Smith, Currie & Hancock, LLP

May 7, 2013

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Presenter Biographies• Gene Rash and Rolly Chambers

– Partners in Charlotte, NC office of Smith Currie & Hancock, LLP

• Smith Currie & Hancock, LLP (http://www.smithcurrie.com)– 60 attorneys devoted exclusively to construction and

government contracts– Focus on construction business legal matters– Offices in Atlanta, Charlotte, Ft. Lauderdale, San

Francisco & Washington, D.C.

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Extended Duration and Performance Construction

Warranties• What will we cover?

– General legal principles for construction warranties

– Extended duration construction warranties – Construction performance warranties– Performance liquidated damages and construction

warranties

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Extended Duration and Performance Construction

Warranties• Why be concerned about construction

warranties? – Construction warranties shift significant risks to

clients– Financial risk of repairing nonconforming items– Clients may misunderstand the risks involved– You can help by recognizing construction warranty

risks and exploring risk mitigation strategies

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General Principles for Construction Warranties

• What is a warranty? – Promise that particular statement of fact is true and

may be relied upon by other contracting party

• “Standard” construction warranty– Materials and equipment new and of good quality– Work free from defects in workmanship– Work conforms to requirements of contract – No express time limit

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General Principles for Construction Warranties

• Contractor will repair defects for 1 year after substantial completion– AIA, ConsensusDocs, EJCDC

• Supplementary conditions may have additional warranty language– Contractor warrants Work “will be free from

defects in materials and workmanship for a period of one year from substantial completion”

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General Principles for Construction Warranties

• Performance bonds and warranties– Incorporate principal’s construction contract,

including warranty obligations– Surety’s warranty obligations derive from

principal’s warranty obligations – Warranty obligations extend beyond completion– Warranty obligations extend beyond final payment

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Extended Duration Construction Warranties

• Construction warranties > 1 year• Owner shifts repair risk to contractor for

longer term period– Public owners increasingly looking for extended

duration warranties – Extended duration warranties stretch owner’s

construction dollars

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Extended Duration Construction Warranties

• Highway construction contracts– State DOT’s face reduced funding– Reduced funding impacts DOT q.c. testing and

inspections– DOT’s require longer duration warranties to cover

risk of correcting quality problems– Pavement warranties can be 3, 5, 7 years

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Extended Duration Construction Warranties

• Building construction contracts– Extended warranties for building components (e.g.

roofs, HVAC equipment, etc.)– Warranty durations may be 5,10, 20 years– If contractor goes out of business during extended

warranty period, then performance bond surety will be liable

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Extended Duration Construction Warranties

• Extended duration warranties impact contractor bonding– Difficult to estimate future financial obligations to

cover extended warranty repair work– Long term warranty obligations extend long after

contract funds are paid – surety concern– Sureties raise underwriting standards for longer term

coverage

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Extended Duration Construction Warranties

• Are there ways to mitigate risks of extended duration warranties?– Assign manufacturer’s long term warranty to owner– Obtain warranty bond separate from performance

bond to cover extended warranty obligations– Limitations through terms of performance bond

• Limit duration of performance bond• Exclude long term warranty language

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Construction Performance Warranties• Contract warranties that concern

performance of completed project• Sustainable (“green”) building

– Project will perform at certain level of energy consumption

• Clean energy projects (solar, wind turbine)– Project will perform at certain level of output

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Construction Performance Warranties

“Green” Building• Sustainable buildings are certified to meet

standards for energy and environmental performance– LEED, Energy Star, green building codes

• Federal, state, and local governments – Increasingly incorporate sustainable building

standards in construction contracts– Want construction warranties that completed project

will perform to “green” building standards

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Construction Performance Warranties

“Green” Building• AIA Guide for Sustainable Projects (2011)

– Disclaims warranty that project design and construction will perform to “green” building standards

– Owner maintenance and operations after completion affect project’s performance

• But … – >20% of U.S. cities over 50,000 in population had

green building programs in 2009

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Construction Performance Warranties

“Green” Building• Federal design-build project - warehouse

– Required design to achieve energy consumption at least 40% below a given baseline (performance)

– Required warranty of project design “through the statute of limitations and statute of repose” (extended duration)

– Required design-builder to furnish performance bond

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Construction Performance Warranties

“Green” Building• Federal design-build project - warehouse

– Government’s remedies for breach• Equitable adjustment (deductive change)• Contractor repair or replacement of defective

item at contractor expense (re-design)• Risk mitigation techniques

– Performance bond covering construction work but excluding design

– Design-build performance bond limiting liability for design (e.g. ConsensusDocs 470 (rev. 2011)

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Construction Performance Warranties

Clean Energy Projects• Solar cell and wind turbine power projects• Developer financing depends on selling a

given level of output– Investors and lenders want assurance from

developer– Developer shifts performance risk to project

designer and contractor with performance warranties

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Construction Performance Warranties

EPC Projects• EPC Contracts

– Engineering, Procurement, and Construction– Type of design-build contract– Commonly used for constructing clean energy or

industrial projects• EPC Contracts include performance

warranties and construction warranties– If project fails to perform to warranted level, then

EPC contractor is obligated to bring performance to the warranted level

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Construction Performance Warranties

EPC Projects• Are there ways to mitigate risks of

performance warranties in EPC contracts?– Errors and omissions insurance from designer for

design defects– Performance warranty insurance from manufacturer

of project components (solar cells, turbines, etc.)– Manufacturers warrant output performance of solar

cells or turbines for long term – 12, 15, 25 years– Manufacturer partners with insurance company– Developer can obtain coverage directly

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Construction Performance Warranties

Performance Liquidated Damages• EPC contracts may provide for both

construction delay and performance liquidated damages– Performance LD’s do not involve delays in

construction– Performance LD’s involve delays in achieving a

warranted level of output– Developer assesses performance LD’s while output

is below warranted level

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Construction Performance Warranties

Performance Liquidated Damages• Are there ways to mitigate risk of

performance LD’s?– Limitation of damages clause can cap an EPC

contractor’s or performance bond surety’s liability for performance LD’s

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Extended Duration and Performance Construction

Warranties• Extended duration and performance

construction warranties shift significant risks to contractors and their sureties

• Trend to include such warranties is likely to increase

• Recognizing financial and legal risks and attempting to mitigation them is crucial

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Contractual Risk Allocation Provisions

QUESTIONS?If you do not have the opportunity to have your question addressed during the session, you may contact the presenters directly:

Gene Rash & Rolly ChambersCompany: Smith, Currie & Hancock, LLPPhone: 704-334-3459Email: gfrash@smithcurrie.comEmail: rlchambers@smithcurrie.comAddress: 1023 W. Morehead St., Suite 301

Charlotte, NC 28208