Bret Gunnell, Chris Mosley, Scott Shea and Jennifer Kirk Morris | Sherman & Howard | September 20, 2016
Colorado law generally prohibits construction defect lawsuits against a construction professional brought “more than six years after the substantial completion of the improvement to the real property.” § 13-80-104, C.R.S. This “ statute of repose ” reflects Colorado’s policy that construction professionals should not be liable indefinitely for defects in their work. This liability cut off applies not only to homeowner suits against those responsible for building projects, but also to indemnification suits brought by general contractors against their subcontractors.
Calculating the date from which the six-year statute of repose runs is the subject of significant litigation in construction defect suits, because the terms “substantial completion” and “improvement” are not defined in the statute. In 2012, the Court of Appeals made clear “improvement” is not synonymous with project, and may be a discrete component of an entire construction project. Shaw Const., LLC v. United Builder Servs., Inc., 296 P.3d 145, 154 (Colo. App. 2012). Shaw determined a single building (or phase) of a multi-phase project is substantially complete, for purposes of the statute of repose, when a Certificate of Occupancy is issued, id. at 155, thus starting the six-year clock for construction defect liability even if work continued past that date. The Shaw court left open the possibility, however, the statute of repose could start to run on a subcontractor’s work before a Certificate of Occupancy was issued. On September 8, 2016, the Court of Appeals walked through that door.
In Sierra Pacific Industries, Inc. v Bradbury, the Court of Appeals ruled the statute of repose for a general contractor’s claims against a subcontractor begins to run when that subcontractor’s scope of work is substantially complete, not when the project is substantially complete. — P.3d —- (Colo. App. 2016). The likely practical effect of this ruling is construction professionals whose work is completed earlier in the project will face shorter exposure to liability for defective work because it is relatively rare for defects to manifest, and suits to be brought, prior to the project’s completion. The ruling effectively creates a construction “grace period” for designers and contractors involved earlier in the construction process.
For example, an excavation contractor who improperly compacts a foundation trench may have completed its work a full year before completion of the drywall, painting, and finish work that will likely show the first signs of the defect. If these defects manifest in the fifth year after drywall installation, the six-year statute of repose already may have run on the excavation contractor, while the drywall contractor remains potentially subject to suit. Further, if the geotechnical engineer was responsible for improperly calculating the compaction of the soil, its liability may have been cut off even before the defect manifests.
While the “grace period” is good news for architects, engineers, and subcontractors who complete their scope of work early in a project, the effect on developers, general contractors and late sequence subcontractors is quite the opposite. The developer’s and general contractor’s work likely is only complete when the project is complete. They face the prospect of being liable for a subcontractor’s defective work without the ability to seek indemnification from that subcontractor, because the statute of repose has run on the subcontractor’s work. Subcontractors who complete their work late in the sequence of a construction project may face increased pressure going forward from suits attempting to attribute defects to their work, rather than a defective substrate completed much earlier.
Management of construction defect risk may require a different, or at least expanded, strategy in this new legal environment. Careful attention should be paid, and definitive records kept, as to when each subcontractor finishes its work on the project. Developers may wish to engage peer review of architects’ and engineers’ work. General contractors may wish to devote more resources to quality control to catch potential defects before they occur. Developers and general contractors may also wish to contract around the risk of losing indemnification rights against early completing contractors and subcontractors. Experienced construction lawyers can draft and recommend contract language preserving such rights to include in future agreements.
Sierra Pacific could have significant impact on general contractors and developers who depend on being named as an additional insured on subcontractor insurance policies as an essential component of an overall risk management strategy for construction defects. Under this strategy, developers and general contractors rely on a subcontractor’s “completed operations” coverage, extended to them under an additional insured endorsement, to protect against construction defect claims. The standard ISO completed operations additional insured endorsement (CG 20 37 04 13) extends coverage to a developer or general contractor for liability arising from the subcontractor’s defective work. Importantly, the endorsement does not condition coverage on the subcontractor’s liability. Thus, in theory, the developer or general contractor should retain additional insured coverage for claims asserted against them even if the subcontractor’s liability has been extinguished by the statute of repose under Sierra Pacific.
Insurers, however, may attempt to argue against coverage for a developer or general contractor on the ground the subcontractor’s liability has been extinguished by the statute of repose. While this position may be incorrect, insurers could force developers and general contractors into expensive litigation to address the issue. Moreover, many insurers issue manuscript additional insured endorsements with language that differs from the standard ISO endorsement, and such endorsements may condition additional insured coverage on a subcontractor’s liability.
Sierra Pacific could pose difficulties for developers and general contractors who insure projects under a wrap – whether an owner’s controlled insurance program (commonly known as an “OCIP”) or a contractor’s controlled insurance program (commonly known as an “CCIP”). The typical wrap commences completed operations coverage (i.e., coverage for construction defects) from the date work on the project is substantially complete. Under Sierra Pacific, an insurer may argue the completed operations period commences as soon as the first subcontractor’s work is completed. For projects which may take a long time to complete, the completed operations period could terminate before the statute of repose expires on claims against developers and general contractors – thus leaving developers and general contractors without the construction defect coverage they thought they had purchased.
To address these issues, developers and general contractors must confirm the subcontractor’s additional insured endorsement triggers completed operations coverage for them based on the subcontractor’s defective work, not the subcontractor’s ultimate legal liability, and that coverage under the endorsement is not undermined by language in the subcontract agreement. Developers and general contractors will need to pay close attention to the completed operations trigger when negotiating OCIP and CCIP wraps. Properly qualified insurance professionals (particularly insurance brokers and experienced coverage lawyers) can assist with negotiating wraps and implementing an effective insurance program to reduce or avoid coverage concerns Sierra Pacific might create.
It is unclear whether the Sierra Pacific decision will be appealed. For the foreseeable future, the statute of repose for defect suits against construction professionals will be calculated from when that professional finishes its scope of work.