Most construction work is done pursuant to a set of plans and specifications issued by the architect that tells the contractor what they are to construct and the owner what they are receiving in exchange for the contract price. That is, the plans and specifications for a construction project describe the contractor's scope of work.
But when work (especially in particularly in large and complex projects) does not conform to the plans and specifications, the parties involved need to understand both their contractual and other legal rights.
In short, many contract provisions give owner's the ability to reject and require the replacement or removal of nonconforming work. However, the parties must also factor in Wisconsin's law respecting damages.
Check Contract Language
Contracts, especially those model forms – such as those from AIA, AGC ConsensusDocs, or EJDCD – usually specify that contractor’s work must be performed in accordance with the referenced plans and specifications.
Kevin Long, Marquette 1992, is a partner with Quarles & Brady LLP in Milwaukee, where he practices in commercial litigation with a focus on construction, real estate, and transportation-related litigation.
However, when an owner uses a simplified or short-form contract, that owner should ensure that the contract form requires that the contractor perform the work pursuant to the referenced plans and specifications, provide new materials and equipment of good quality, and that the work is performed in a workmanlike manner.1
While under Wisconsin law, performance not in compliance with the required plans and specifications is likely a contractual breach as well, without the explicit language, a contractor might contend that it complied with the contract merely by constructing the project.
The AIA Document A201-2017 form explicitly requires the contractor to correct all work that is either rejected by the architect or does not conform to contract requirements, either before or after substantial completion.2 The AIA form also gives the owner the option to accept nonconforming work:
§12.3 ACCEPTANCE OF NONCONFORMING WORK
If the Owner prefers to accept Work that is not in accordance with the requirements of the Contract Documents, the Owner may do so instead of requiring its removal and correction, in which case the Contract Sum will be reduced as appropriate and equitable. Such adjustment shall be effected whether or not final payment has been made.
AGC 200 ¶3.9 and EJCDC C-700 ¶¶13.06-07 each include similar language, but refer only to "defective work," a defined term that includes nonconforming work.
Decisions During Construction
While most contractual language explicitly gives the owner the right to reject nonconforming (or defective) work before or after substantial completion, the practicalities of each differ significantly.
After substantial completion, requiring the correction or replacement of work is much more likely to cause problems for the owner's immediate use of project. More importantly, under the most common contract forms, the contractor's retainage is released upon the achievement of substantial completion. Accordingly, the contractor has significantly less financial incentive to promptly undertake the corrective work.
Thus, it is very important for the owner (and its architect) to be vigilant with inspections and other observation to ensure the work being done meets the contract requirements before final payment is released. When defects are identified during construction, the owner is in a better position to insist on what it bargained for, and the schedule impact of the repair or replacement will be minimized.
The Diminished Value Damages Rule Limits Owner's Remedy
Wisconsin law holds that if correcting the defect or supplying the omitted labor or product involves unreasonable economic waste because the costs of correction are materially disproportionate to the increased value that it would produce, then the recovery is limited to the difference between the value of the improvement had it been properly constructed and the value as actually constructed.
Wisconsin law on these issues is summarized authoritatively in Pattern Jury Instruction Wis. JI-CIVIL 3700, entitled "Building Contracts: Measure of Damages.”3
It is difficult to determine with precision the difference the value the improvement would have had if properly constructed and its value as actually constructed, particularly where the nonconformity does not preclude the use and/or occupancy of the building.
Under the dispute resolution mechanism of the AIA forms, the "initial decision maker" (usually the architect) can make that determination, but the initial decision maker’s determination is not entitled to deference in future dispute resolution proceedings.
In litigation, the determination of damages will most often by left to the jury, unless the parties have waived their right to jury. Real estate appraisers are generally not experienced in drawing distinctions between the real estate value if properly constructed and the real estate value as constructed, but they are often called upon to serve as experts in this capacity. Indeed, two of three generally accepted real estate valuation approaches (the income approach and the market comparable approach) do not typically involve an evaluation of component parts of structure or piece of real estate within that context.
Equitable Adjustment of Contract Price
The AIA, AGC, and EJCDC forms each explicitly allow the owner to accept nonconforming work, while receiving an equitable adjustment to the contract price in exchange. Neither the contract forms, nor authoritative Wisconsin caselaw provides a basis for how the adjustment should be calculated.
The amount is purportedly designed to be a compromise amount agreed upon by the contractor, who seeks to avoid the cost of the repair or replacement, and the diminished value damages calculation that the owner knows will cost a significant amount of money to obtain through the contractually mandated dispute resolution process.
Important Take-Aways
Understand what your contract says about nonconforming work before your client signs it. An owner needs a provision that grants it the right to insist upon repair or replacement of nonconforming work, and the contractor will seek to limit that right.
It will be very difficult to locate definitive caselaw, statutory authority, or even expert testimony on the appropriate equitable adjustment to which an owner is entitled when the owner accepts nonconforming work.
The owner's leverage is best when the nonconforming work is found early in the project and worst when found after substantial completion.
The owner should include contractual language that monetizes the equitable adjustment or streamlines the dispute resolution process for such adjustment, including designating that determination of the initial decision maker is binding in such circumstances. The contractor will likely resist such decisions.
Conclusion: Be Vigilant During Construction
Owners have more leverage to get work performed properly and in conformance with project specifications, or an equitable adjustment of the contract price, where the nonconformities are discovered during the project, rather than after substantial completion.
This article was originally published on the State Bar of Wisconsin’s Construction and Public Contract Law Section Blog. Visit the State Bar sections or the Construction and Public Contract Law Section webpages to learn more about the benefits of section membership.
Endnotes
1 See, e.g., AIA Document A201-2017 General Conditions to Contract, § 3.5.1.
2 AIA A201-2017, § 12.2.1.
3 Citing W.G. Slugg Seed & Fertilizer, Inc. v. Paulsen Lumber, Inc., 62 Wis.2d 220, 224-25, 214 N.W.2d 413 (1974). See also, "Modern status of rule as to whether costs of correction or difference in value of structure is proper measure of damages for breach of construction contract,” 41 A.L.R.4th 131; and "Repair or Replace? The Economic Waster Doctrine in Construction Defect Cases,” 84 AUG Wis. Law. 4, 4+.
