Risk Management Articles
Too Much, Too Little: Exposures From Certification of Payments
By Steven G.M. Stein, Esq.
Joel J. Rhiner, Esq.
Design professionals have become increasingly subject to claims arising out of their design and construction administration services. The obligation of the design professional to issue payment certificates has long been a tedious and dreaded task and one that often creates numerous liability problems. Although the only real purpose of issuing payment certificates is to inform the owner or lender that the contractor is entitled to payment, these certificates are often used by potential claimants as a basis for many types of legal actions. This article will explore 1 the potential liability exposures faced by design professionals from issuing payment certificates; 2 the status of case law involving design professionals and their obligation to issue payment certificates; and 3 what design professionals can do to minimize their liability exposure while participating in the payment process.
POTENTIAL LIABILITY EXPOSURES
By issuing payment certificates, the design professional makes a potential claimant out of everyone involved in the construction process. Those people from whom the design professional can expect claims include prime contractors, owners, subcontractors, sureties and construction workers who have suffered personal injuries.
Claims by Prime Contractors.
The most common complaint voiced by prime contractors against design professionals is that of undercertification. When a design professional undercertifies a payment request, they are recommending that too little money be paid out by the owner to the prime contractor. The prime contractor might claim that the design professional was negligent and undercertified the work because the design professional failed to accurately measure the progress of the work. If the design professional does undercertify payment, the prime contractor may be harmed and denied needed resources to complete its work, possibly resulting in a default. In the case of defective work, the prime contractor will undoubtedly point to the payment certificates which are issued by the design professional as evidence that the owner and the design professional accepted the work.
Claims by Subcontractors.
Subcontractors often expect the design professional to act as watchdog to make sure that the prime contractors are paying them with the proceeds received from the owner. If the design professional fails to monitor the payments made by the prime contractor to the subcontractor, the subcontractor may argue that the design professional was negligent and caused a diversion of funds. By failing to monitor such payments, the design professional could be said to have denied the subcontractor of needed resources to complete its work, which could possibly lead to a default.
Claims by Sureties.
Sureties may have claims against design professionals for both overcertification and undercertification. If the design professional undercertifies payment and causes a contractor default, the surety may be forced to complete the contractor's work. Similarly, if the design professional overcertifies payment, thereby reducing the amount of retainage needed to adequately complete the job, the surety may be forced to complete the contractor's work, upon default, with insufficient funds.
Claims by the Owner.
Claims brought by owners against design professionals represent the greatest variety of potential claims. The owner may allege that the design professional negligently overcertified payments or may allege that the design professional was negligent for failure to adequately supervise the work. Most owners rely upon the issuance of a payment certificate by the design professional to determine whether the contractor is entitled to payment. If the design professional overcertifies payment, thereby recommending that payment be made for work that is not yet done or for patently defective work, the owner may be injured. When the design professional overcertifies payment, the amount of retainage held by the owner as security for default or defective work is reduced. This, of course, could leave the owner with insufficient funds to complete the project.
In the case of defective work, the payment certificates issued by the design professional are typically used by the owner to attempt to hold the design professional responsible for the contractor's work. The owner may allege that the design professional was responsible for inspecting the work prior to issuing payment certificates to make sure that the work conformed with the Contract Documents. Owners may also view payment certificates as a guarantee by the design professional that the work was properly done.
Claims by Construction Workers.
Claims brought by construction workers against design professionals, whether for negligence, may be brought based upon the design professional's duty to issue payment certificates. A construction worker who is injured on the job site may allege, by inference, that the duty of the design professional to issue payment certificates necessarily requires that the design professional visit the site to check on the progress of the work, and that while checking on the progress of the work, the design professional has a duty to protect people on the job from any unsafe construction practices or defective conditions.
The few cases which have addressed the duty of the design professional to issue payment certificates have analyzed that duty based upon responsibilities similar to those set forth in the standard form AIA Agreements. Despite the use of the typical disclaimer clauses used by the AIA, which protect the design professional from liability for issuing payment certificates, the design professional is often the subject of litigation.
Negligent Overcertification Cases.
There have been few reported decisions in Illinois regarding the potential liability exposure of a design professional for undercertifying or overcertifying payment requests. Beginning with the case of City of Chicago v. Agnew, 106 N.E.2d 252, 264 Ill. 288, Illinois courts have held that contractors and sureties have standing to assert claims of "negligent overcertification" against owners and others with whom they are in direct contractual privity. The law is much less clear, however, whether those same contractors and sureties would have standing to assert claims of "negligent overcertification" against design professionals with whom they do not have contractual privity.
The court in Southern American Insurance Co. v. E.W. Corrigan Construction Co. et. al., 1991 U.S. Dist. Lexis 10368 (N.D. Ill. 1991) held that the surety of a subcontractor, who defaulted on the job, could not bring an action against the architect who allegedly overcertified the work of the subcontractor, thereby depriving the surety of its primary source of security to mitigate the costs of completing the subcontractor's work. The court reasoned that neither the subcontractor nor the surety had a contract with the architect and therefore the architect owed no legally cognizable duty to the subcontractor or the surety. As support for its decision, the court cited the well known decision of Moorman Mfg. Co. v. Nat'l. Tank Co., 91 Ill. 2d 69, 61 Ill. Dec. 746, 435 N.E.2d 443 (1982), which prohibits the recovery of economic loss in tort actions.
More recently, Judge Jack Hoogasian of the Circuit Court of Lake County in Montessori School of Lake Forest v. Aetna Casualty and Surety Company of Illinois, et. al., 92 L 1027 (1994), held that a surety could bring a claim for "negligent overcertification" against an architect with whom the surety had no contractual privity. In that case, the Montessori School of Lake Forest, as owner, filed a lawsuit against the General Contractor who worked on the job and its surety for defective work. The surety filed a third-party complaint against the architect alleging that the architect negligently overcertified payments due the General Contractor, thereby reducing the amount of funds needed to complete the work. The architect moved to dismiss the third-party complaint on the grounds that the surety was not a third-party beneficiary to the Owner/Architect Agreement and that the surety could not recover economic losses against the architect for its alleged negligent certification of payments.
The surety filed a brief in response to the architect's motion to dismiss and argued that the surety was a third-party beneficiary to Owner/Architect Agreement because the surety was explicitly given the right to use any retainage to complete the job and was to benefit by the use of this retainage. The surety also argued that regardless of whether it was a third-party beneficiary to the Owner/Architect Agreement, the architect owed the surety an independent duty to correctly estimate the progress of the work and to only certify and approve conforming work for payment. The surety stated that the architect's representations concerning certification of payments were negligent and because the architect was allegedly in the business of supplying information, the Moorman doctrine did not apply and the surety could bring a claim for negligent overcertification. The court, in an unpublished opinion, held in favor of the surety.(1)
The liability exposure of design professionals for negligence, based upon issuing payment certificates, can be greatly reduced provided that design professionals take particular care when negotiating their contracts with owners. The potential liability exposure of a design professional for negligence, whether brought by owners or personal injury claimants, typically depends upon whether the design professional has any responsibility for site inspection or review of the contractor's work for compliance with the Contract Documents.
In Corbetta Construction v. Lake County Bldg.Commission, 64 Ill. App.3d 313, 21 Ill. Dec. 431, 381 N.E.2d 758 (2nd Dist 1978), the Court held that the architect was negligent and liable to the owner for the contractor's defective work because the architect, who had agreed to supervise the construction, should have discovered the contractor's defective work. In Busick v. Streator Township High School, 234 Ill. App. 3d 647, 175 Ill. Dec. 423, 600 N.E.2d 46 (3rd Dist. 1992), the Court held that the architect was not liable to an injured construction worker for job related injuries because the architect had no duty to supervise the work, nor was he responsible for worker safety. In reaching its decision, the Court noted that the legal duty of a design professional to third persons, such as construction workers and other personal injury claimants, is based upon the scope of the design professional's agreement with the owner (whether the design professional has agreed to inspect and supervise the work).
HOW THE DESIGN PROFESSIONAL CAN MINIMIZE LIABILITY EXPOSURE WHILE PARTICIPATING IN THE PAYMENT PROCESS
Unquestionably, the best way for design professionals to protect themselves from liability arising out of the payment process is to avoid issuing payment certificates. Some owners may be willing to relieve the design professional of the duty to issue payment certificates and perform this task themselves, or delegate it to a construction manager, in order to retain greater control over the payment process. If an owner is willing to absolve the design professional from the headaches which typically accompany issuing payment certificates, the design professional should accept the offer. More commonly, the owner will request that the design professional issue payment certificates. The following suggestions are ones that the design professional should consider when an owner has requested that the design professional issue payment certificates.
The Design Professional Should Only Be Held To A "Negligence" Standard.
Both the B141 and A201 Agreements seek to limit the liability exposure of the design professional, for issuing payment certificates, by creating a negligence standard. These standard forms of agreement carefully provide that such certificates are based upon the "knowledge, information and belief" of the design professional, making it clear that the design professional shall be held only to the professional standard of care -- not a guarantee -- in the exercise of its certification function. Paragraph 2.6.10 of the B141 Agreement sets forth the primary duties of the design professional to issue payment certificates:(2)
"The Architect's certification for payment shall constitute a representation to the Owner, based on the Architect's observations at the site as provided in Subparagraph 2.6.5 and on the data comprising the Contractor's Application for Payment, that the Work has progressed to the point indicated and that, to the best of the Architect's knowledge, information and belief, quality of the Work is in accordance with the Contract Documents. The foregoing representations are subject to an evaluation of the Work for conformance with the Contract Documents upon Substantial Completion, to results of subsequent tests and inspections, to minor deviations from the Contract Documents correctable prior to completion and to specific qualifications expressed by the Architect. The issuance of a Certificate for Payment shall further constitute a representation that the Contractor is entitled to payment in the amount certified. However, the issuance of a Certificate for Payment shall not be a representation that the Architect has (1) made exhaustive or continuous on-site inspections to check the quality or quantity of the Work, (2) reviewed construction means, methods, techniques, sequences or procedures, (3) reviewed copies of requisitions received from Subcontractors and material suppliers and other data requested by the Owner to substantiate the Contractor's right to payment or 4 ascertained how or for what purpose the Contractor has used money previously paid on account of the Contract Sum."
In addition to limiting the design professional's certification by a "knowledge, information and belief" standard, Paragraph 2.6.10 sets forth other protections for the design professional. As discussed in Section III (C) of this Article, Paragraph 2.6.10 attempts to absolve the design professional from having any control over the work and from making continuous or comprehensive on-site inspections. This language is important to the design professional because it specifies that any on-site visits made by the design professional are for checking the progress of the work, rather than an "inspection" of the work for compliance with the contract documents, which can give rise to a negligence or Structural Work Act claim.
Paragraph 2.6.10 also gives the design professional the right to retract his previous representations that the Work is in accordance with the Contract Documents, "subject to an evaluation of the Work for conformance with the Contract Documents upon Substantial Completion." This language, once again, illustrates the narrow purpose of the payment certificates and makes it very difficult for an owner or surety to argue that a design professional should be held liable for contractor deviations at the progress payment stage.
The significance of including exculpatory language, like that used in the AIA standard form agreements, is underscored by the fact that some owners believe that by issuing payment certificates, the design professional is giving his "guarantee" or "certifying" that the contractor has complied with the plans and specifications. Of course, if the design professional actually "certifies" that something is perfect, he is assuming a level of liability well beyond the standard of care required by the law. This is significant for insurance reasons, as well as potential liability reasons, because certificates for payment can be construed to be warranties or guarantees, especially when the certificate contains representations of fact upon which the Owner will rely, and the design professional's insurance does not typically cover claims for breach of warranty:
"This insurance does not apply to liability assumed by you under any contract; but that this exclusion does not apply if you would have been liable, in the absence of such contract, due to your own error, omission or negligent act."
When negotiating an Owner/Architect Agreement, the design professional should explain to the owner that the provisions in the B141 and A201 Agreements, which provide that payment certificates are issued based upon the design professional's "knowledge, information and belief," benefit both the design professional and the owner by triggering the design professional's insurance coverage. If the owner wants the design professional to be exposed to liability which is not covered by insurance, the design professional should request to be paid for those services and more money should be allocated for comprehensive site inspections by the design professional.
Demand a Schedule of Values.
Prior to issuing any payment certificates, the design professional should insist on receiving a detailed Schedule of Values from the contractor. The A201 General Conditions (Paragraph 9.2.1) requires that the contractor provide the architect with a detailed Schedule of Values, but does not specifically state whether the design professional's payment certificate is a representation that a certain percentage of the work is completed, or that the amount which the contractor seeks coincides with the actual amount of labor and materials put in place.
Typically, the design professional compares the percentage of work completed against the schedule of values, rather than attempting to analyze the actual value of the work. Nonetheless, some owners are now requiring the design professional to certify that the original schedule of values submitted by the contractor accurately allocates the contract sum among the various trades in order to avoid contractor front loading. An example of this type of responsibility is as follows:
Design Professional shall review and approve the Contractor's schedule of values and certify that the schedule accurately represents the amounts to which the Contractor should be entitled for the Work described in each line item and that the Contractor's schedule of values is of sufficient detail to allow the Design Professional to certify that the Contractor's Applications of Payment are accurate representations of the value of the Work put in place.
If possible, the design professional should avoid taking on this type of responsibility. The design professional's duty to issue payment certificates should only be an indication that the work "has progressed to the point indicated" (see A201, 9.4.2), and not a summary of how the money was spent. It should be left up to the owner/lender to make sure that the money paid to the contractor is used properly.
Protect Yourself From Negative Inferences.
Most lawsuits against design professionals, based upon their role in the payment process, are founded upon negative inferences typically drawn from payment certificates. It is common for contractors and owners to equate the duty of the design professional to issue payment certificates with that of inspecting the work for compliance with the Contract Documents. To avoid this negative inference, design professionals should include language in all of their contracts to make clear that they are not in charge of the work, nor required to make exhaustive or continuous on-site inspections. Both the B141 and A201 Contracts contain appropriate language like this which should be incorporated into any contract entered into by the design professional. Specifically, Paragraph 2.6.10 of the B141 and Paragraphs 4.2.2 and 4.2.3 of the A201 absolve the design professional from having any control over the work and from making continuous or comprehensive on-site inspections.
The duty of the design professional to issue payment certificates exposes the design professional to a variety of potential claims. The design professional may face claims for negligence and for alleged Structural Work Act violations, as well as claims for negligent overcertification and undercertification of payments. In order to minimize the design professional's exposure to such claims, the design professional should, whenever possible, attempt to utilize standard form AIA documents or incorporate the concepts discussed in this Article into any contract entered into by the design professional.
- Courts in other jurisdictions have also held that design professionals may be liable for overcertifying payment requests. For example, in State ex rel. National Surety Corp. v. Malavaney, 221 Miss. 190, 72 So. 2d 424 (1954), the court held that an architect was liable to a surety for negligent certification of payments. See also U.R.S. Company Inc. v. Gulport-Biloxi Regional Airport Authority, 544 So. 2d. 824 (Miss. 1989); Aetna Insurance Company v. Hellmuth, Obata & Kassabaum Inc., 392 F.2d 472 (8th Cir. 1968).
- Paragraph 2.6.9 of the B141 and Paragraph 4.2.5 of the A201 Agreements similarly provide that "[b]ased upon the Architect's observations and evaluations of the Contractor's Application for Payment, the Architect shall review and certify the amounts due the Contractor."
Steven G.M. Stein, Esq. and Joel J. Rhiner, Esq. Stein, Ray & Conway ("SRC") is one of the largest firms in the United States exclusively devoted to construction law. SRC represents many of the country's largest owners, design professionals and contractors in contract formation, risk management and insurance, business counseling, and dispute resolution. SRC has handled some of the country's highest profile design and construction cases.
The information in this and all other RISK Administration and Management Company articles is intended for information and risk management purposes only and does not constitute legal advice. For legal advice and assistance, please contact competent counsel in the jurisdiction of your professional practice.