Professional Development: Construction Defect Litigation And Economic Damages

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By Stanley Stephenson, Ph.D.
Published in the May 2012 issue of Today’s Facility Manager

Construction defects to a facility can lead to large and complex legal disputes between facility owners and contractors. What might facility managers (fms) expect and what can they do? Here are a few suggestions based on actual litigation.

Have historical operation and financial records available. A common claim is that the facility has lost money from reduced occupancy and incurred increased operational costs as a result of defects or disruptions during repairs due to reconstruction. Damage experts often develop models showing trends in operations if no defects had occurred and compare those with actual trends. Fms who have an actual history will assist both sides in the dispute.

Consider hiring extra staff. It often happens that a liaison is needed between the person in charge of reconstruction and the facilities operations. Extra duties can be quite varied and may include special programs to maintain operations.

Be prepared to spend before the lawsuit is decided. In one case, construction defects caused water to enter hallways and living quarters at a large apartment complex. Water intrusion led to mold and mildew which adversely impacted the intended use of the building by reducing the number of occupants and caused lost revenue from other sources.

The facility claimed lost profits from operations, extra repair costs, and miscellaneous expenses. In this case, defects were due to poor roofing. Not only did the roof need to be redone, but the water damage to walls, floors, stairwells, and other areas also had to be remediated. The facility maintained operations during reconstruction and reduced room rates as an incentive to offset excess vacancies.
Economic damages began once the defects interrupted normally planned enjoyment and use of the property. Damages expanded in many ways over time as more issues surfaced. They continued during the reconstruction period and well after the defects had been repaired. It may sound simple, but the calculations and litigation were complex.

Who conducts the damage assessment, and how can fms help out? Damages in construction defect cases are best handled by those experienced with large complex situations involving hotels, commercial properties, or hospitals. The financial expert may need to take on an “operations research” role and work with the technical/construction side of the project to estimate costs associated with alternative repair schedules. A frequent issue is whether or not building occupants can continue working during reconstruction or must be moved to another facility.

Fms should consider the following case of a long-term care hospital for dementia patients. The hospital had been wrongly built on an earthquake fault in California. Over time, cracks appeared in the foundation, walls, and parking lot; major repairs were needed.

At first, experts believed the property had to be emptied during repairs, but with the assistance of fms, a rolling schedule was worked out. This meant occupants could be moved temporarily into “swing rooms” during the reconstruction phase of the project. This not only reduced project costs, it also minimized the adverse impact of moving patients off-site. (Note: any time substitute space is needed, damages include loss of actual or implied “rent” plus the added cost of substitute space.)

How are lost profits determined? Construction defect litigation involves two main parts: who is liable and who must pay. Sometimes courts consider each issue separately and assign partial responsibility for liability and damages. (Fms can assume damages are comprised of lost profits from operations, plus extra one time charges.)

There are different ways to calculate lost profits, but a commonly used technique is the before/after method in which one first compares and contrasts what profits might have been during the damages period with actual profits during the same time. In practice, however, an experienced expert may go beyond strict use of this approach (although there may be some cases where the before/after method might not accurately reflect the impacts the facility is experiencing). The damages expert needs to consider factors such as market factors, economic conditions, and seasonality even if no construction defects have occurred.

Other adjustments to measured losses may involve extraordinary expenses incurred due to construction defects such as repair costs, extramarketing, gifts, or sales efforts. The fm plays a key role in administrating these concessions and gathering this information.

What is the scope of damage? The scope of damages may include repair and reconstruction costs, plus lost profits to business interruption, and extra costs incurred just due to the defects. The plaintiff must prove lost profits. Loss of revenue from revenue sources for the facility (such as food and drink operations, parking, and convention and meeting room operations) may also be involved. Finally, the facility may have lost its competitive positioning due to the defects, disruptions during repairs, and the lingering perception of operational problems that need to be addressed by special marketing campaigns and promotions. Assessing the full scope of such damages can take a very long time: fms should not settle too soon before all damages are known.

Critical communications. Construction defect litigation is complex. Lawyers for both sides may have to engage—and rely on—the opinions of many experts. The expert list may include contractors, designers, architects, plumbers, electricians, mold specialists, soil engineers, and financial experts: all for each side. An experienced financial expert typically draws on the other experts’ work and provides a summary opinion regarding repair costs, lost value, and other damages.

Communication is very important and may include meetings among property owners and fms, the various repair and reconstruction contractors, their attorneys, and the experts they engage to prepare for the case. A special master may offer coordination.

Coordination and information sharing thus become important to successful outcomes. Clear, ongoing lines of communication are absolutely critical.

Stephenson is managing principal of Tampa, FL-based Litigation Economics LLC, a national firm that works with lawyers to put a proper value on business losses. He taught economics at Penn State University and the University of Hartford, and has been retained in more than 375 cases over the last nine years, representing either plaintiffs or defendants.

 

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