CONSTRUCTION LAW FOR THE NON-CONSTRUCTION

ATTORNEY

Sponsor: Young Lawyers Division CLE Credit: 1.0

Wednesday, June 13, 2018 2:25 p.m. - 3:25 p.m.

Thoroughbred 1-3 Lexington Convention Center

Lexington, Kentucky

A NOTE CONCERNING THE PROGRAM MATERIALS

The materials included in this Kentucky Bar Association Continuing Legal Education handbook are intended to provide current and accurate information about the subject matter covered. No representation or warranty is made concerning the application of the legal or other principles discussed by the instructors to any specific fact situation, nor is any prediction made concerning how any particular judge or jury will interpret or apply such principles. The proper interpretation or application of the principles discussed is a matter for the considered judgment of the individual legal practitioner. The faculty and staff of this Kentucky Bar Association CLE program disclaim liability therefore. Attorneys using these materials, or information otherwise conveyed during the program, in dealing with a specific legal matter have a duty to research original and current sources of authority.

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TABLE OF CONTENTS The Presenter .................................................................................................................. i In Over Your Head?? Construction Law for the General Practitioner .............................. 1

Chapter One - Introduction .................................................................................. 1 Chapter Two - Construction Participants .............................................................. 1 Chapter Three - Project Delivery Methods ........................................................... 5 Chapter Four - Contracts ..................................................................................... 7 Chapter Five - Alternative Dispute Resolution .................................................... 21 Chapter Six - Origin and Nature of Mechanics' Liens ......................................... 23

THE PRESENTER

Stephen E. Smith Goldberg Simpson, LLC

Norton Commons 9301 Dayflower Street

Prospect, Kentucky 40059

STEPHEN E. SMITH is a partner with the Louisville law firm of Goldberg Simpson, LLC. His primary areas of practice are construction, public acquisition, and corporate law. Before joining the firm in 1989, Mr. Smith served the public sector with the United States Army Corps of Engineers for 15 years. As District Counsel, and as senior legal advisor to the commander, he was responsible for construction claims and dispute resolution. Since entering private practice, Mr. Smith represents all sides of construction matters, including public and private owners, large general contractors and construction managers, as well as specialty subcontractors. He devotes a considerable amount of his time as a commercial mediator and arbitrator. He is a member of both the American Arbitration Association Panel of Construction Arbitrators and Panel of Construction Mediators. He is approved as a mediator and arbitrator for all disputes arising under the Greater Louisville Association of Realtors. Mr. Smith has been selected by members of the Louisville Bar as a Louisville Magazine's "Top Lawyer" in the areas of "Construction" and "Arbitration" and "Mediation- Non-Family" for the last four years. He has been selected as a Kentucky "Super Lawyer" annually since 2007. He was selected to "Best Lawyers in America in 2015 and 2016. Mr. Smith earned both his B.A. and his J.D. from the University of Louisville. He is a frequent lecturer and instructor in the areas of federal acquisition and construction claims administration. He is a member of the Louisville, Kentucky and Federal Bar Associations, the ABA Forum on The Construction Industry, and a founding member of the Kentucky Bar Association Construction and Public Contract Law Section.

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IN OVER YOUR HEAD?? CONSTRUCTION LAW FOR THE GENERAL PRACTITIONER

Stephen E. Smith © 2018

CHAPTER 1 INTRODUCTION The construction industry comprises the largest single segment of the American economy. It has been said that as construction goes, so goes the nation. Fortune 500 has started listing service corporations, with several construction companies located near the top of this prestigious reference list of American industry. For all of the prominence of the construction industry in the American economy, precious little attention is paid by the American legal community to the particular problems which are experienced by construction owners, developers, contractors, suppliers, and design professionals. Legal rules of evidence, standards of proof, and many of the principles of Anglo-American common law – developed in other civil cases involving negligence, personal injury, breach of contract, and the like – do not always readily apply to the legal problems faced by the construction industry. Nothing is more frustrating to a contractor than to experience cost over-runs on a construction project – knowing that the cost impact of those disruptions can be economically devastating. Likewise, nothing is more frustrating to a construction owner or developer than to try to comprehend just how a contractor who is made to perform exactly the amount of work set forth in the contract documents and no more can claim huge damages for seemingly insignificant changes or disruptions to the sequence of the project work. Melding the realities of construction with the requirements of the law is made more difficult in jurisdictions such as Kentucky which do not have a large volume of legal precedent dealing directly with construction litigation. Residential construction is even more difficult. There are not generally large sums of money to finance change orders or cost overruns. Most builders cannot afford to carry three or four homes on their construction lines of credit and need to get paid for their work pretty quickly. Most subcontractors are pretty small businesses, and their employees need to get paid every Friday. And importantly, most home owners have unreasonable expectations when it comes to the construction of their "dream home." The purpose of this manual is to attempt to help attorneys and counselors understand the principals of construction law and the practicality of home or small commercial construction projects, so attorneys are better able to advise their clients through these difficult circumstances. CHAPTER 2 CONSTRUCTION PARTICIPANTS 2.1. THE OWNER – PRIVATE OR PUBLIC

The most important participant in a construction project, the party with the most leverage, is generally the owner. The owner serves as a focal point of discussion for two primary reasons: (1) the construction of the facility must meet the owner's

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needs, and (2) the owner provides financing for the project. However, the owner's involvement in the construction process may vary considerably from project to project. Ownership can range from the very simple as in the case of a homeowner contracting for construction of a patio and paying cash out of pocket to the very complex as in the case of a major developer building a privately managed office complex. Regardless of complexity, each project involves the drafting and execution of a contract. The contract is the key to understanding the roles of the parties.

2.2. THE DESIGN PROFESSIONAL

Construction projects of any magnitude and all statutorily defined public buildings require owners to retain the services of licensed designed professionals. State legislatures regulate the practice of design professionals and have enacted statutory provisions relating specifically to the licensing and practice of architecture and engineering. This statute can be utilized to prevent unlicensed individuals from practicing architecture or engineering. It also can be used to prevent engineers from practicing architecture and vice versa. Most people associate the role of a design professional with that of an architect. However, state licensing statutes require the involvement of separate professionals for the separate design disciplines of architecture, structural engineering, mechanical engineering, geotechnical engineering, and depending upon the complexity of the project, various other sub-disciplines. Normally, an owner will contract directly with a lead design professional for a project. That design professional will, in turn, subcontract elements of the overall project design to other disciplines. For example, in the case of a high-rise apartment complex, the lead design professional would normally be the architect, who would contract directly with the owner and then subcontract other phases of the design to a structural engineer, a mechanical engineer, and so forth. On the other hand, in the development of a sewage treatment plant with only ancillary building construction, the lead design professional could be an environmental engineering consulting firm, that would contract directly with the owner and subcontract the building construction portion of the project to an architect, the foundation design to structural and geotechnical engineers and so forth. Today, the sciences of architecture and engineering exist in an age of specialization, increasing governmental regulation, technical innovation, and economic pressure. It is not enough for design professionals to possess the basic skills of the profession; they must also be experienced in the particular type of work undertaken. The need for competent, capable, and experienced design professionals exists on any project. This need increases geometrically with a project's size and complexity.

2.3. THE CONTRACTOR

A contractor is a company that has a direct contractual relationship with the owner. The contractor generally contracts with separate subcontractors and

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material suppliers in order to complete the final project. The contractor has the affirmative duty to pay those who provide services or materials to the project. It also bears responsibility for the potential failure of subcontractors or material suppliers. For these reasons, the contractor is usually at the center of any controversy concerning defective construction claims and payment issues. In most projects the owner will contract with a single, general contractor that will be responsible for all of the work. The general contractor will, in turn, contract with various trade subcontractors and material suppliers for completion of the individual segments of the project.

2.4. SUBCONTRACTORS

Subcontractors possess expertise in particular specialized trades. Under most circumstances, subcontractors bid one portion of the overall project plans and specifications developed by the owner and design professional. Subcontractors can have either a direct contractual relationship with a contractor or a second or third tier subcontract with another subcontractor who is higher in the project chain of command. Many times the parties to a construction project end up in a great deal of legal confusion when subcontractors are not receiving timely payments for their work. Under traditional contract doctrine, subcontractors would have a difficult time securing payment because they are not in contractual privity with the owner. In the event that the owner is late in paying the contractor and the contractor is consequently late in paying the subcontractor, there is little the subcontractor can do except sue the contractor. The mechanic's lien statutes (KRS 376.010 et seq.) give the subcontractor a direct avenue of recourse against the owner.

2.5. MATERIAL SUPPLIERS

Parties that provide supplies to construction projects occupy much the same place in the contract chain of command as do subcontractors. Whether or not a party is considered a subcontractor or a material supplier, however, may determine whether or not lien rights exist. A material supplier may not always be able to perfect a mechanic's lien as readily as a subcontractor. For lien rights to accrue, material must be identifiable to a specific project. Suppliers of material sold "off-the-shelf" may have difficulty in identifying the specific project for which the material is utilized. In addition, whom the material supplier provides the material to also determines whether lien rights exist.

2.6. SURETIES

Though not prevalent in most residential construction, virtually any large construction project requires general or prime contractors to provide performance and payment bonds. Often critical subcontractors must provide bonds as well. Bonds are third-party beneficiary contracts between a contractor, as principal, and a bonding company, as surety. Under the terms of these bonds, the surety occupies the position of a solvent party to whom the owner, as a third-party

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beneficiary, can look for completion of the construction work in the event of the contractor's default (performance bond), and to whom individuals beneath the contractor in the chain of command can look for payment, as third party beneficiaries, in the event of the contractor's default (payment bond). The role of the surety in the construction process is critical in the event of default or insolvency of a principal. Payment bonds provide another source of security for subcontractors and material suppliers for performance on a construction project and give owners some comfort that claims will not be made against their property by subcontractors and material suppliers.

2.7. CONSTRUCTION LENDERS

The party who "stakes" the other active players in the construction game is the construction lender – usually a commercial financial institution. This party is critical to the completion of a successful construction project. The bank will typically arrange to have construction funds released to the owner on a periodic basis during the course of a construction project. Upon completion of the project, many owners refinance and convert their indebtedness from short-term construction financing to long-term permanent financing. In each instance, the construction lender is given a mortgage security interest against the project itself. The presence of other encumbrances on the project, such as mechanics' liens or other mortgages, will frustrate the construction lender and delay the financing process.

2.8. PROSPECTIVE PURCHASERS

While a prospective purchaser may not come on the scene until long after a construction project is finished, the law of mechanics' liens is important to this party. A mechanic's lien can cloud the title to property, causing a prospective purchaser to have an interest in understanding the status of liens filed against the property and resolving those liens prior to the purchase if necessary. In the event that liens cannot be removed, many purchasers will work with their title insurance company to separately handle liens that may be determined valid.

2.9. THE INTERNAL REVENUE SERVICE AND STATE WITHHOLDING AGENCIES

While the Internal Revenue Service and state withholding agencies are normally not direct parties to a construction contract, they are always present in the process and seldom far from the scene. Various governmental agencies and employee benefit trusts have statutory rights to assert levies against contract funds for unpaid taxes and benefits. These levies have priority over most contractor payment obligations. When the tax man breaks into the pay line ahead of other construction creditors, the creditors' worst fears about the business acumen of the debtor is usually confirmed.

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CHAPTER 3 PROJECT DELIVERY METHODS 1. INTRODUCTION

1.1. Construction contracting is a business characterized by the constant assessment and management of risks. Allocation of the responsibility for construction risks among the construction parties has evolved through court decisions and contract language. For example, most courts hold owners responsible for delays that they cause to a contractor. Likewise, many contract forms allocate the risk of differing subsurface conditions to the owner. There has been an increasing tendency, however, on the part of some parties, particularly owners and general contractors, to attempt to reallocate the responsibility for construction risks to the contractor by including risk shifting provisions in their construction contracts.

1.2. In reality, however, the attempt to shift risk and responsibility begins with

the selection of the "delivery method" or the method of contracting by the owner. The very framework under which the goods or services are acquired can dictate the manner in which the majority of the risks and responsibilities are assigned.

1.3. There is a vast number of contract types to choose from in obtaining

construction performance: fixed price, lump sum, cost plus, cost plus fixed fee, cost plus percent of costs, construction manager, construction manager at risk, design build, fast tract, multiple prime, plus many others.

1.4. However, with each choice comes a consequence. Each of those

methods carries with it a set of risks and responsibilities that must be considered prior to selection. Some of these issues will be discussed in this section.

2. FAST TRACK

2.1. Fast-track construction is generally employed when rapid completion of the project is a high priority, for example, when the cost of funds is high or the deadline is important to the owner. This method of acquisition is often found in school board contracting where the deadline cannot usually be moved, and it is important to move quickly.

2.2. Often, it arises in cases of disaster or emergency where the need has

been sudden and the time available for planning and design is not available and allows for a beginning of construction with only a minimal amount of planning. It allows for the remainder of the design to be accomplished during the stages when foundation and infrastructure construction is continuing.

2.3. The distinct disadvantage of that method lies in the fact that many

changes may be necessary in the work that has already been accomplished due to the lack of proper advanced planning in the early design. As the needs of the owner are more fully developed, the things that have already been built may have to be modified.

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2.4. Significant additional costs may result from delay situations which may arise for the amount of time necessary to design the later stages of the project, when the design does not keep pace with construction. These costs can usually be overcome with certain contract clauses which limit the contractor's ability to make a claim for delays.

3. MULTI-PRIME CONTRACTING

3.1. Multiple prime contracting, also known as "parallel prime contracting" can help owners achieve their goal of a quality project, on time, and within budget. In this manner of contracting, the owner contracts directly with a number of specialty or trade contractors. Each trade contractor is responsible for the performance of a discrete portion of the work, but no single contractor is responsible for the entire project. Instead, the responsibility for putting all of the pieces together resides with the owner.

3.2. This method provides the owner with the opportunity to reduce the time

and cost of construction and to assume greater control of the work. It also increases the risk to the owner through coordination requirements. Coordination issues are often the most significant hazards to multiple prime contracting.

3.3. Owners may be able to insulate themselves from liability for lack of

coordination or be able to transfer that liability for lack of coordination by contract and impose it on the prime contractors. Because owners have been able to shift their duty to coordinate successfully, the aggrieved prime contractor on a multi-prime contract may be limited to an action against another prime contractor or left with no recourse at all.

4. DESIGN-BUILD

4.1. Simply put, design build projects are those which are designed and constructed by one organization. The benefits are well recognized: 1) single point responsibility for design and construction to help avoid conflicts and the shifting of liabilities between contractors and design professionals; 2) the ability to fast track construction, which lowers overall costs and allows earlier use of the completed facility; 3) the owner's ability to quickly determine the costs of construction; and 4) supposedly higher motivation of designer-builder to achieve performance criteria required by the owner.

4.2. This method is increasing in use and has been for the last ten years.

Owners believe it improves the quality in project delivery and in the final product. Use of the format should address constructability from the outset and minimize the conflict between contractor and designer which normally exists.

4.3. Major concerns lie in the ability of the contract to properly assign project

responsibilities. Contract language must be clear in shifting all responsibility for design and constructability to the contractor.

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4.4. Historically, construction projects were delivered by the design-build method with the designer in charge. The A/E was called the master builder and had overall responsibility for the project, including both design and construction. The legal climate has changed to the extent that the threats to the designer have required that it retreat to a narrow niche.

4.5. In the early days of renewed design-build, where the contractor had

become the lead actor, the designer assumed a subservient role. In many projects today, the designer takes the lead role in the project.

5. CONSTRUCTION MANAGER

5.1. The concept of construction management is the management of resources on a construction project. It has been defined as the process of professional management applied to a planning, design, and construction project from inception to completion for the purpose of controlling time, scope, cost, and quality.

5.2. Role of construction manager arises when owners make an assessment

of their capabilities to manage the construction process. An owner who regularly engages in the various aspects of management, design, building and payment for a project may determine that he or she can adequately oversee the amount of work necessary to be performed. However, when owners determine that the effort is too large for their resources, then they may turn to a construction manager.

5.3. While the roles of owner, architect, engineer or contractor are easily

defined, the role of construction manager is dependent upon the specific contract requirements, the owner's expectations, and the capability of the manager.

6. AT-RISK CONSTRUCTION MANAGEMENT

6.1. Generally, this method of contracting involves the use of a guaranteed maximum price to the owner. The CM carries the risk of failure to see that the job is performed in accordance with the allowable dollars estimated in the bids. This satisfies the problems in normal construction management in tying the risk of failure to the partner who has the responsibility to see to performance.

CHAPTER 4 CONTRACTS 1. THE LAW OF A CONSTRUCTION PROJECT Every construction project has a law that is unique to that project. That law is

comprised of three components: statutory law, common law, and the contract.

1.1 The statutory law consists of the laws, statutes, and ordinances passed and enacted by the U.S. Congress, the state legislature, and local governmental units. These include not only the laws themselves, but also the regulations that are adopted to implement the laws. The federal Miller

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Act and the state mechanic's lien statute are two examples of statutory laws. In addition, the EPA and OSHA regulations and the Kentucky Administrative Regulations (KARs) are examples of regulations adopted to implement various laws.

1.2 The second component of the law of a construction project is the common

law, or the judge-made law. The common law consists of the opinions written by the courts of appeals in the various jurisdictions that set out the law that will be followed in that jurisdiction. Examples of common law are the economic loss rule (whether or not a particular state will enforce the economic loss rule), enforcement of pay-when-paid clauses, and the enforcement of indemnification clauses (if a state does not have an anti-indemnity statute).

1.3 The third component of the law of a construction project is the contract

itself. The contract is as important, if not more important, than either the statutory or common law. Through the contract, the parties can modify the statutory law (if the modification is not against public policy). For example, by contract a party can waive the mechanic's lien rights that it has by statutory law. In addition, a pay-when-paid clause can be worded in the contract to ensure the clause will be enforced even in those jurisdictions that by common law restrict its enforcement. Therefore, care and attention must be paid to the contract that is signed by the parties. All of the contract must be reviewed before signing, not only the terms set out in the contract itself, but also all documents that are incorporated into the contract by reference.

2. STANDARD FORM CONTRACTS

2.1 The successful completion of a construction project requires the careful coordination of the labor forces of the general contractor and sub-contractors, the delivery and storage of materials to be incorporated into the project, as well as direct, clear communication between the participants in the project. For this reason, the "contract" is the focal point of virtually every relationship in a construction project. The contract assigns the rights, risks, and responsibilities to the respective parties to the contract.

2.2 Standard form contracts serve an important function in the construction

industry. These forms are convenient, economical, should promote a more equitable allocation of risks and responsibilities, and should be more comprehensive in scope than forms developed specifically for individual contracts or individual segments of the construction industry. Further, court decisions interpreting the clauses included in standard form contracts permit participants in a project to know in advance how courts may view the meaning of particular clauses and give other courts precedent to use if subsequent interpretation should become necessary.

2.3 Standard form contracts are generally developed by organizations

interested in defining the contractual relationship between various groups providing services in the construction industry. Although the philosophical

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views and biases of the sponsoring organizations are often reflected in certain parts of standard forms, the forms generally are not unreasonable, one-sided documents protecting the membership of the sponsors.

2.4 When asked to enter into an agreement which incorporates a standard

form contract, first check the edition of the standard form to determine whether there have been any changes from editions which may be more familiar.

2.5 Carefully consider each standard form contract. Although the form may

appear to be primarily boiler-plate, and thus, less important than the plans and specifications, the forms contain important risk-sharing and remedy-granting provisions that will affect performance costs and dictate certain contract administration practices. Be alert to possible alterations in the form, such as additions, deletions, and word changes – either by delineation or supplementary conditions.

2.6 Finally, study the list of clauses incorporated by reference into the

contract and obtain copies of those clauses in order to assess the parties' established rights, risks, and responsibilities.

3. REPRESENTATIVE FORMS

3.1 Critical contract clauses from seven major sources of standard form contracts used throughout the Commonwealth of Kentucky are discussed below.

3.2 AMERICAN INSTITUTE OF ARCHITECTS

The American Institute of Architects (AIA) has drafted and sponsored standard form contracts since the 19th century and revises its documents at eight to ten year intervals. By far the most significant, and the cornerstone, of all of the AIA documents is AIA Document A201, General Conditions of the Contract for Construction. It is the most widely used standard form construction contract in the United States. The AIA recently published its latest edition of this document in electronic format for purchase. Both the City of Lexington and the City of Louisville utilize the AIA documents for their construction procurements, incorporating appropriate modifications to meet their particular needs.

3.3 ENGINEERS' JOINT CONTRACT DOCUMENTS COMMITTEE

The Engineers' Joint Contract Documents Committee (EJCDC) prepares standard form contracts for use by professional engineers in private practice. The joint committee is comprised of the National Society of Professional Engineers, the American Consulting Engineers' Council, the American Society of Civil Engineers, and the Construction Specifications Institute.

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While the AIA documents cover the field of building construction, the EJCDC documents primarily cover transportation, utilities, energy, water, sewage, environmental, and other similar projects which involve "infrastructure" engineering. The City of Lexington also utilizes the EJCDC standard form contract for appropriate construction projects.

4. KENTUCKY FINANCE AND ADMINISTRATION CABINET, DEPARTMENT FOR

FACILITIES MANAGEMENT

The department's Division of Contracting and Administration has developed stan-dard general conditions, which are incorporated into the cabinet's construction contracts. Although the University of Kentucky and the University of Louisville fall under the jurisdiction of the Finance and Administration Cabinet, they procure their construction work. Their construction contracts incorporate the cabinet's general conditions.

5. KENTUCKY TRANSPORTATION CABINET, DEPARTMENT OF HIGHWAYS

The general provisions for construction of roads and bridges for the Department of Highways appear in the Kentucky Transportation Cabinet's Standard Specifications for Road and Bridge Construction, 1985 edition, in Sections 101 through 110.

6. CRITICAL CONTRACT CLAUSES

6.1 SCOPE OF WORK CLAUSE

The amount of profit on a project and the scope of work are inextricably related. Accordingly, contractors must consider the exact language of the provision in their contract with the owner which delineates the scope of work. The "scope of work" is a general phrase which means the actual and reasonably anticipated breadth of the undertaking. It is imperative that contractors study all contract documents carefully to ensure that they have taken into account all the work in their bid. Even if the contract documents are drafted with a great deal of clarity, the contractor must realize that the scope of work includes all work which is indispensable to the performance of the specified work. The fact that this indispensable work is not expressly stated in the specifications is no defense. It is imperative that the contractor study all the contract documents carefully to ensure that he or she has taken into account all the work in his or her bid. In Setzer v. Whitehurst,1 the Kentucky Court of Appeals

1 339 S.W.2d 454 (Ky. 1960).

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held that even though the subcontractor did not see the specifications, where the evidence shows that they were made available for his or her inspection during the period of time the work was in progress, he or she cannot be heard to say that he or she did not know that certain work and materials were required to be performed. Likewise, the contractor must be aware of disclaimers which are included in the contract documents. In one important Kentucky case, Codell Construction Company v. Commonwealth,2 a contractor claimed that soil conditions existing on a road construction project differed from the soil information published by the Kentucky Department of Highways. The Department published the results of its soil survey on the project drawings along with an express and unqualified disclaimer as to the accuracy of the soil conditions. The court disallowed the contractor's claim for additional compensation because the disclaimer put any bidder on notice as to his or her obligation to make his or her private investigation, and the parties should have realized that the estimates might well be inaccurate.

6.2 ORDER OF PRECEDENCE CLAUSE

The instructions on how to construct a project are contained in the contract documents. These documents consist of a series of interrelated provisions, specifications, drawings, details, and notices which are intended to complement each other as they guide the contractor through the project. The contract documents include boiler-plate specifications and details which are typical for all projects as well as special provisions and drawings which are developed specifically for the project at hand. The formidable task of integrating these various documents into one harmonious set could never be done without some ambiguities remaining in the contract documents.

Ambiguous language in contract documents is a common source of construction disputes. In many cases, the ambiguity can be resolved by resorting to an "Order of Precedence" clause. Ambiguities fall into two categories, patent and latent. A patent ambiguity is one which is readily noticed, while a latent ambiguity is hidden within the contract documents. A contractor has an obligation to seek out from the owner or the architect or engineer an interpretation of patent ambiguities in the plans or specifications before he or she bids the job. All these clauses require the contractor to notify the architect or engineer immediately upon discovery of a discrepancy or ambiguity in the contract documents. If a contractor fails to clear up the patent ambiguity, he or she will bear the risk of any loss arising from a costlier interpretation. On the other hand, if an ambiguity is latent, the contractor has a better opportunity to make claim on the basis that the scope of work has actually been increased; because he or she was unable to tell due to the latent

2 566 S.W.2d 161 (Ky. App. 1977).

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ambiguity in the plans, he or she would be required to do more than he or she envisioned when his or her bid was submitted.

6.3 TIME IS OF THE ESSENCE AND LIQUIDATED DAMAGES CLAUSES

Contractors are invariably subject to the proposition that "time is money." However, courts generally hold that time is not of the essence in construction contracts. Therefore, if the owner is able to assert a claim for delay against the contractor, the prime contract must expressly state that time is of the essence. Most modern construction contracts contain this language and, in fact, usually specify a date by which the project is to be completed. This proposition is typically linked with a liquidated damages provision in the construction contract. Liquidated damages provide the owner with a method for obtaining compensation from the contractor for each day of delay caused by the contractor. These provisions are very common in public works contracts and are occasionally found in private agreements. When the parties have agreed to a liquidated damages clause, it becomes the exclusive remedy for the owner for delay. Thus, an owner cannot obtain liquidated damages and then actual damages caused by delay as well. In order for a liquidated damages clause to be enforceable, the amount of the liquidated damages must be a reasonable estimate of the probable loss the owner will experience by the contractor's delay. Liquidated damages must be compensatory in nature and cannot be punitive.

6.4 NOTICE CLAUSES

One of the abiding fears of construction owners is that at the end of the work, the contractor will present a long list of extras which arose during the course of the work, but which the owner had no knowledge that the contractor was considering to be extras. To alleviate this problem, most construction contracts require that the contractor notify the owner, in writing, within a specified time that a problem exists and that a claim will be made. Theoretically, this notice will insure that the owner is aware of the problem and can take appropriate technical steps to remedy the problem. Owners frequently defend against a contract claim by alleging that the contractor failed to strictly comply with the contract notice requirements. This defense is generally unsuccessful. Rather than dismissing an otherwise valid claim because of a notice deficiency, a court will generally require an owner to demonstrate that it has been prejudiced by the lack of proper notice. Prejudice may result from the loss of material witnesses or documentation, or the inability to properly investigate the facts. Notwithstanding this general rule, several jurisdictions do not look as kindly on a failure to comply with the notice requirements in the contract and have imposed upon the contractor a duty to strictly comply with the

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notice requirements without looking into whether there was prejudice. This situation recently occurred in Indiana v. Omega Painting, Inc.,3 and resulted in the contractor losing an otherwise valid claim. In the Kentucky case of Smith v. Ferguson,4 the Court denied the contractor's claim for extras for his or her failure to give proper notice before proceeding with the claimed extra work. However, where the parties to the contract have ignored the contract provisions while acknowledging the extra work, the contractor will recover. Every effort should be made during contract performance to comply as completely as possible with all notice requirements in the contract. This goal should be made clear to field supervisors and other on-site personnel who are in a position to document job-related problems.

6.5 WAIVER

Waiver and release is generally a defense to specific allegations or claims based on contract clauses. Waiver has been defined as:

The voluntary and intentional relinquishment of a known right, claim, or privilege….Waiver is a voluntary act and implies election by a person to dispense with something of value or to forego some right or advantage which he might at his option have demanded or insisted upon.

A waiver operates to preclude a subsequent assertion of the right waived or any claim based thereon. However, it must be shown by the party claiming the waiver that the party against whom the waiver is asserted had knowledge, actual or constructive, of his or her rights at the time the waiver occurred. Generally, only the person for whose benefit the right or privilege was intended, or his or her duly authorized agent, may waive a contractual right. A question of whether the words or actions of a party constitutes waiver frequently arises in the construction context in connection with a contractor's failure to obtain a written change order for extra work and for failure to give notice for a claim for extra compensation as required by the contract. The owner's intention to waive these contract rights must be proven and this can lead to serious evidentiary problems. Such a waiver may be found in a course of conduct. For example, where the owner issues oral directives and then pays for that extra work, he or she will not be permitted to suddenly impose the writing requirement on subsequent extras.

3 463 N.E.2d 287 (Ind. Ct. App. 1984). 4 295 S.W.2d 792 (Ky. 1956).

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Standard form contracts contain numerous clauses by which parties waive various rights and claims. For example, paragraph 4.3.5, "Waiver of Claims: Final Payment" of AIA Document A201 provides that:

The making of final payment shall constitute a waiver of claims by the owner except those arising from...

Likewise, other contract provisions provide that the parties specifically do not waive their rights. For example, paragraph 13.4.2, "Rights and Remedies" AIA Document A201, provides that:

No action or failure to act by the owner, architect, or contractor shall constitute a waiver of a right or duty afforded them under the contract, nor shall such action or failure to act constitute approval or acquiescence in a breach thereunder, except as may be specifically agreed in writing.

6.6 DELAY CLAUSE

Most construction contracts for projects of any significance include clauses covering delay in performance and time extensions. Projects are delayed for a wide variety of reasons and the contractor should be aware as to the responsibility for various types of delays. Some delays are the result of occurrences beyond the control of either the contractor or the owner. Yet many delays result from the failure of one or more parties to fulfill their contractual obligations. There are generally four kinds of possible delay on a construction project: (1) Excusable; (2) Compensable; (3) Non-excusable; and (4) Concurrent. Not all delays result from the conduct of the contracting parties. When outside forces delay completion of the work, the delay is termed "excusable" under most contracts. Normally, excusable delays are synonymous with those things which are covered in a force majeure clause which excuses the contractor from timely performance in the event of certain circumstances such as a storm, an act of God, a fire, a strike, a war, or other governmental actions for which neither the contractor nor the owner are responsible. Courts often rule that the contractor is entitled to an extension of time for an excusable delay but is not entitled to any additional compensation arising from the delay, and he or she will be relieved of any liability to the owner for damages as a result of late completion.

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A compensable delay, on the other hand, arises from an act on the part of the owner and is one for which the contractor can recover compensation in addition to an extension of the contract performance period. Compensable delays often stem from work suspensions, design defects, changes, differing site conditions, and owner-caused interferences, such as the failure of the owner to provide access to the construction site. The Kentucky Fairness in Construction Act provides that any attempt by the owner to waive responsibility for his or her delays is unenforceable. The third kind of delay is a non-compensable delay. This is a delay which is caused entirely by the contractor's fault in performance. If the contractor has failed to coordinate his or her work, failed to schedule the delivery of materials, or failed to bring enough workmen or equipment to bear on the project, then the contractor is not entitled to any additional compensation and is not entitled to an extension of time in which to complete the contract. Furthermore, the contractor can be liable to the owner and others for delays which are attributable entirely to him or her. The final kind of delay is a concurrent delay, a particular segment of time on a project when both the owner and the contractor are simultaneously causing delay to the work. The rule with regard to compensation for concurrent delays is mixed. In some states, an owner cannot recover for a concurrent delay and neither can the contractor since an allocation between the two parties would arguably be arbitrary and without factual basis. On the other hand, there are states in which the courts now attempt to apportion concurrent delays between the owner and the contractor.

6.7 NO DAMAGE FOR DELAY CAUSE

Many construction contracts contain a "No Damage for Delay" clause which seeks to prevent the contractor from recovering damages for time delays. Because delay claims have proved expensive, owners today frequently use such clauses to avoid responsibility for project delays. Unfortunately, contractors too often notice the clause for the first time when preparing their delay claims. By then it is too late. On the other hand, owners who rely too heavily on the no damage for delay clause can have a false sense of security. A poorly drafted clause can expose the owner to delay claims. Even a well-worded clause is subject to exceptions which, if applicable, leave the owner vulnerable. The Kentucky Fairness in Construction Act holds owners' attempts at "no damage for delay" clauses as unenforceable.

6.8 SUSPENSION OF WORK CLAUSE

A suspension is a form of delay resulting from the owner interrupting the course of work for a period of time. "Suspension of Work" clauses benefit both the contractor and the owner. They provide the owner with the latitude to temporarily halt construction; for example, the owner experiences funding or right-of-way problems while providing that the

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contractor will be fairly compensated for his or her additional costs and performance time resulting therefrom. However, the contractor must show that the government was the sole cause of the suspension before recovery will be allowed. Contractors dealing with federal construction contracts are expressly allowed to recover in delay situations where no formal affirmative suspension order is issued, but where the effect of the owner's action or inaction is the same. It is important to recognize that the reasonableness of the time taken by the government to act, or in its failure to act, depends upon the circumstances. For example, in Azerind, Inc., the Armed Services Board of Contract Appeals awarded delay damages to the contractor when the government took two months to respond to the contractor's materials submittals. The board held that in the absence of a contract provision to the contrary, 10-14 days are generally allowed for turning around shop drawings and submittals.

6.9 CHANGES CLAUSE

If the world were perfect, there would be owners and design professionals who know exactly what they want and contractors who understand exactly what they are supposed to do. Under these utopian conditions, there would be no need for contract clauses dealing with changes. However, because people, who are not perfect, are involved from the inception of the construction process, the "changes" clause is essential to every construction contract. The purpose of the clause is to allow modification of the written agreement between the parties. It enables the owner to order variations in quantity, quality, or method without breaching the contract or obtaining the consent of the contractor. If the contractor signs a contract with a changes clause in it, he or she forfeits his or her right to consent to an owner's change to the scope of the work. The key items on which a contractor based his or her bid may be changed, but he or she is to be compensated in a manner which preserves his or her status under the contract at the time the change is issued. The changes clause is also a mechanism which operates as a bookkeeping system. Each party will know at any given point and time what he or she owes and what he is entitled to receive. Under the AIA's General Conditions, a change order is distinguished from a construction change directive. A change order is by definition an agreement between the owner, contractor, and architect. The construction change directive is a written order prepared by the architect and signed by the owner which directs a change in work and states a proposed basis of adjustment in either contract sum, contract time, or both. Change orders are invariably the source of contractual disputes. Traditionally, courts have been hesitant to ignore the plain language of a

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contract requiring, as a condition precedent to recovery, a written change order. Accordingly, owners who have been sued for extra work by contractors often invoke the formal change order procedure as a defense to the claim. Courts in some jurisdictions have maneuvered around these seemingly strict requirements to allow recovery by the contractor under the theories of apparent authority, waiver, and quantum meruit or unjust enrichment.

6.10 CONSTRUCTIVE CHANGE

Even without a formal change order, the owner may become obligated to pay for work orders. A "constructive change" arises when the contractor is required to perform work on a construction project which is different from or in addition to the work set forth in the original agreement. Showing that the owner directed the additional work is the key. The term "constructive change" was, at one time, almost exclusively associated with government contracts. It was viewed as governmental conduct which was not a formal change order, but which has the effect of requiring the contractor to perform work different from that prescribed by the original contract. Although the term is used less frequently in connection with private construction contracts, the concept is well known in that context.

6.11 CARDINAL CHANGE

As the AIA document A201 "changes" clause indicates, changes are to

be within the scope of the contract. If the contractor finds himself confronted with an undertaking substantially different from that which he or she had originally contemplated due to the extensive changes ordered by the owner or dictated by the owner's actions, then a cardinal change exists. The term "cardinal change" basically refers to a change ranging beyond the scope of the contract, which constitutes a material breach of contract. In that situation, the contractor has the right to disregard the contract and seek compensation for the reasonable value of his or her services.

In most instances, whether a cardinal change has occurred depends

upon the determination of a factual question. As a practical matter, cardinal changes are quite rare.

6.12 CHANGED CONDITIONS OR DIFFERING SITE CONDITIONS CLAUSE

Every contractor performing under a fixed price contract determines his or

her price based on certain basic assumptions concerning the conditions he or she will encounter; unanticipated conditions, such as concealed subsurface conditions, can greatly disrupt project scheduling and otherwise increase the cost of the work.

To prevent contractors from inflating their bid prices to cover this

contingency, most owners include "changed conditions" or "differing site

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conditions" clauses in the contract to allow for price adjustments in case such conditions are encountered. On the other hand, to reduce the risk they are assuming, owners sometime include disclaimers in the contract concerning the accuracy of the information provided by the owner.

The inclusion of a "changed conditions" or "differing site conditions"

clause in the contract provides the means for dealing with differing site conditions. It should be stressed that the contractor's recovery is not automatic. Rather, the contractor must establish that his or her situation is one which falls within the scope of the clause.

In order to make a claim under a changed condition clause, the contractor

is not required to show that the owner is at fault. Instead, the clause allows the contractor to recover his or her additional costs regardless of the owner's honest failure to discover or reveal the actual conditions.

6.13 INDEMNIFICATION CLAUSE

An indemnity clause is a common feature in most construction contracts.

It is one of the most feared and least understood clauses. Contractual indemnification is a major tool for allocating the risks of loss among the various participants in construction projects. Most construction contracts contain an indemnification provision whereby one party agrees to be responsible for and hold harmless another party from all claims for damages arising from the performance of the work which that other party would otherwise be legally responsible.

An indemnitor's liability will depend upon the scope of the damages

covered by the indemnification agreement. Under the AIA form, contractors are required to defend and hold harmless owners against claims, suits, or damages, regardless of whether any loss has been suffered, or whether any liability has been shown to exist.

A contractor should secure contractual liability insurance to protect him

from all of the indemnification he or she has assumed under the contract. If necessary, supplementary umbrella policies should be obtained. Subcontractors should be required to provide certificates of insurance and any necessary renewal certificates for the duration of the project to cover their indemnification liability.

6.14 DISPUTES CLAUSE

By reason of their inherently complex nature, construction projects

generate disputes. Unquestionably the best way to handle a dispute is to avoid it altogether. However, since that is not always possible, the contract documents provide a mechanism for resolving disputes.

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6.15 TYPICAL CONTRACT LANGUAGE

Definition: A claim is a demand or assertion by one of the parties seeking, as a matter of right, adjustment or interpretation of contract terms, payment of money, extension of time or other relief with respect to the terms of the contract. The term "claim" also includes other disputes and matters in question between the owner and contractor arising out of relating to the contract. Claims must be made by written notice. The responsibility to substantiate claims shall rest with the party making the claim.

6.16 Decision of Architect: Claims, including those alleging an error or

omission by the architect, shall be referred initially to the architect for action as provided in paragraph 4.4. A decision by the architect, as provided in subparagraph 4.4.4., shall be required as a condition precedent to arbitration or litigation of a claim between the contractor and owner as to all such matters arising prior to the date final payment is due, regardless of (1) whether such matters relate to execution and progress of the work; or (2) the extent to which the work has been completed. The decision by the architect in response to a claim shall not be a condition precedent to arbitration or litigation in the event (1) the position of architect is vacant; (2) the architect has not received evidence or has failed to render a decision within agreed time limits; (3) the architect has failed to take action required under subparagraph 4.4.4 within 30 days after the claim is made; (4) 45 days have passed after the claim has been referred to the architect; or (5) the claim relates to a mechanic's lien.

6.17 ARBITRATION CLAUSE

If attempts at settlement and formal negotiation of construction disputes

prove fruitless, a contractor has two alternatives: arbitration or litigation. Although arbitration and arbitration agreements have been in existence for a long time, their utilization in the construction industry is rather recent. The availability of arbitration as an alternative, however, depends upon whether or not the contract contains an enforceable arbitration clause covering the dispute.

Arbitration allows disputing parties to present their positions to a quasi-

judicial arbitrator or panel of arbitrators, while avoiding many of the drawbacks and technicalities of the normal judicial process. However, arbitration also has its drawbacks. The pros and cons most frequently cited are:

(1) Speed of resolution – arbitration is often used as a means of

circumventing the multi-year waiting period that is common with congested court calendars.

(2) Arbitration, however, can be a time-consuming process if there is

not a strong arbitrator on the case if one party drags his or her feet or attacks the scope of validity of the arbitration clause in a court proceeding.

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(3) Cost savings – Depending upon the parties and the complexity of the issues, arbitration can be less costly than a comparable court proceeding. This is not, however, normally the case.

(4) Technical expertise of the arbitrators – Presentation of the claim to

a panel of arbitrators which have expertise in the construction industry, rather than a judge or jury with only a layman's knowledge of technical points, is generally cited as an advantage of arbitration.

(5) Privacy – Arbitration does have the advantage of privacy; the

results are not a matter of public record. (6) Avoidance of legal technicalities – In arbitration proceedings, strict

rules of evidence do not apply, and arbitrators are generally liberal in their acceptance of evidence.

(7) Lack of discovery – There is generally no discovery in arbitration

unless agreed to by the parties, specifically authorized by statute, or ordered by a court. This inability to compel discovery can be both a drawback and an advantage depending upon the status of a party's own knowledge of the facts and documentation.

(8) Limited scope of judicial review – Because the arbitrator's function

is a quasi-judicial role, their award will not be overturned by a court unless there is proof of fraud, corruption, or gross negligence.

(9) The well-drafted contract clause providing for arbitration could be

the critical factor determining its enforceability. Utilizing such wording as "the parties may submit to arbitration" will not eliminate but rather inspire litigation as to its interpretation and enforceability. A mandatory arbitration clause is enforceable in Kentucky in light of the Kodak Mining Company v. Carrs Corporation case and the Kentucky Arbitration Act, KRS Chapter 417.

6.18 TERMINATION CLAUSES

Most commercial construction contracts contain a provision giving a

dissatisfied party the express right to terminate or cancel the contract for default if any of the occurrences specified in the termination provision take place and recover damages caused by the terminated party's actions. If the contract does not contain a termination clause, there is an implied common-law right to terminate. However, since construction contracts usually cover an extended duration and require many specific and discrete aspects of performance, a party to a construction contract may not exercise his or her implied right to terminate for minor or trivial performance failures. In other words, a breaching party must have committed a material breach of his or her contract obligations before this implied right can be exercised.

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Most public contracts, and some commercial contracts, also contain a termination for convenience clause which allows the owner, or in some cases, the general contractor, to cancel a contract for virtually any reason. Unlike a default termination, a termination for convenience cannot be used to cancel a commercial construction contract unless there is an express clause in the contract; that is, there is no implied right to terminate for convenience.

CHAPTER 5 ALTERNATIVE DISPUTE RESOLUTION

1. When cooperation fails, alternative dispute resolution (ADR) provides various

methods to facilitate settlement or to utilize consensual dispute resolution mechanisms, starting with direct negotiations between the parties and ending with binding arbitration. Changes in risk allocation would be the most effective means of avoiding disputes and resulting litigation in the construction industry. Risks should be allocated to the parties best able to control or ensure against the risk. Instead, in today's competitive environment, the risks are most often allocated to parties with the least leverage, which is normally the party least likely to be in a position to control the risk. What appears to be a cost-saving mechanism often results in more costly performance due to the risk being included in the bid price or, alternatively, the cost of the resulting litigation.

2. ADR can be utilized under the appropriate circumstances to provide a less costly,

more effective means of resolving these construction disputes that appear to be inevitable under today's economic circumstances. ADR is an alternative means to resolve disputes among the parties in lieu of litigation. There is no magic method that exists. Any process whereby the parties – either by agreement among themselves or through the intervention of third parties – come to a resolution of their dispute, is, by definition, Alternative Dispute Resolution. Despite there being no limitation on the processes two parties might employ to resolve the dispute between them, over the years there has evolved several methods which have proven to be effective under the appropriate circumstances. These methods range from something as simple as negotiation between the parties on one end of this spectrum to binding arbitration on the other end of the spectrum.

3. The following will describe some of these more established methods and

attempt to identify their respective pros and cons. An attempt will also be made to identify some of the factors which should be considered in deciding which method to employ or whether to utilize ADR at all as opposed to litigation. As will be seen, the answer is not always black and white.

4. In 1854, the Supreme Court of the United States in the case of Burchett v. Mars,

58 U.S. 344 (1854), first specifically upheld the rights of parties to agree contractually to have an arbitrator decide matters submitted to them finally and without appeal. In so doing, the court held:

Arbitrators are judges chosen by the parties to decide matters submitted to them, finally and without appeal. As a method of settling disputes, it should receive every encouragement from courts of equity.

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5. As has been discussed above, there are certain characteristics somewhat unique to the construction industry and the construction process that make disagreements and disputes during the course of most construction projects virtually inevitable. These circumstances include such things as the following: the existence of multiple parties on the project site and the need to attempt to coordinate them; specifications that are not always clear or are subject to multiple interpretations; unforeseen site conditions; changing site conditions; weather; and the economic well-being of the various parties on a project. Thus, disputes and disagreements among the parties on a construction project should be anticipated and a method for resolving these disputes and disagreements concurrently as they arise should be contemplated and made a part of the contract documents.

6. MEDIATION

The mediation process involves the parties coming together in the presence of a neutral third party to discuss the relative merits of their positions with regards to a claim or a potential claim. The objective is for the parties themselves to come to a resolution of the issues by agreement. In a peer mediation proceeding, the mediator has no authority to make a binding decision.

The role of the mediator and his or her ability is the key to the success of the mediation process. The mediator works to convince the parties that they will benefit from reaching an agreement by assisting each in assessing the facts of their dispute and the applicable law and pointing out to each the relative strengths and weaknesses of the party's positions. An experienced mediator through this process can oftentimes facilitate the parties finding a point of agreement.

7. ARBITRATION

Arbitration is likely the most recognized as well as most utilized of the ADR processes. This is particularly so with respect to the construction industry. While arbitration proceedings can vary considerably, generally speaking, arbitration involves the non-judicial determination of disputes by either an individual arbitrator or a panel of arbitrators with the decision being either non-binding or binding on the parties. The principal distinction between arbitration and mediation is that in arbitration the arbitrator or arbitrators, as the case may be, make a determination as to the resolution of the dispute; while in mediation, the mediator makes no determination but attempts to facilitate a mutual resolution among the parties. As mentioned above, the arbitrator's determination can be either non-binding or binding though binding arbitration is by far the most common. Because arbitration results in an actual determination of the dispute on its merits by a non-judicial process, the legality of both the agreement to arbitrate as well as the decision itself has been the subject of much judicial scrutiny. The legal aspects of arbitration agreements and decisions will be discussed in more detail below. Normally, arbitration follows an unsuccessful effort by the parties to mediate their dispute. The arbitration process is relatively simple in its purest form. The parties

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meet at a mutually agreed upon location in the presence of an arbitrator or an arbitration panel. The parties are normally represented by legal counsel but the participation of legal counsel is not mandatory. The arbitration proceeds in a similar fashion to a bench trial only on a much less formal basis. The parties will usually make an opening statement, followed by direct testimony, cross-examination and documentary proof. After all of the evidence has been fully presented, the arbitrator(s) may request or the parties may agree to submit legal briefs setting forth the applicable law on any relevant legal issues. Thereafter, the arbitrator(s) normally has a prescribed period of time within which to make a determination and render a decision. In most cases a decision will be rendered without a written opinion.

Arbitrators generally have very broad authority. They may issue subpoenas, fix the date of hearings, grant or deny postponements, and proceed with a hearing in the absence of a party who fails to appear after being notified. The arbitrator's authority, unless otherwise prescribed by statute, is derived from the agreement of the parties.

CHAPTER 6 ORIGIN AND NATURE OF MECHANICS' LIENS

1. PROPERTY INTERESTS SUBJECT TO MECHANICS' LIENS

a. Private Projects

Section 376.010(1) of the Kentucky Revised Statutes provides in relevant

part: Any person who performs labor or furnishes materials, for the erection, altering or repairing of a house or other structure or for any fixture or machinery therein, for the excavation of cellars, cisterns, vaults, wells or for the improvement in any manner of real property including the furnishing of agricultural lime, fertilizer, concrete pipe or drainage tile, crushed rock, gravel for roads or driveways, and materials used in the construction or maintenance of fences, by contract with, or by the written consent of, the owner, contractor, subcontractor, architect or authorized agent, shall have a lien thereon, and upon the land which the improvements were made or on any interest the owner has therein, to secure the amount thereof with interest as provided in KRS 360.040 and costs (emphasis added).

A mechanic's lien may attach to the property interest of the person or entity who, either directly or through its agent, contracts for the work or materials provided, and it is solely that person's or entity's property interest that can be subject to sale to satisfy the lien. It should be noted that, as stated within the statute, a mechanic's lien may attach to the actual structure for which the services and/or materials in question have been provided, the actual parcel of property upon which the structure is situated or even both.

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Furthermore, as used in this statute, the term "owner" is not limited to such person or entity who is the outright owner of a parcel of real property in fee. In other words, the lien may attach to any property interest that is transferable, assignable or conveyable in the real estate of the person at whose request a building, structure or improvement thereon has been erected. Therefore, a mechanic's lien may attach either to an estate in fee simple or to a less estate, such as a leasehold interest. The application of these principles is relatively straightforward. If the owner of the improvement is also the owner of the property in fee, the mechanic's lien attaches not only to the improvement but also to the real property as well. If the owner of the improvement merely has a leasehold interest in the real property, the mechanic's lien attaches only to the leasehold interest of the owner and not to the real property itself. In this instance, the lien is not limited only to the improvement placed on the real property, but it encompasses the entire interest of the owner in the leasehold and all of the leased premises. Where a mechanic's lien attaches to a leasehold interest, the value of the lien is subject to the terms and conditions of the lease itself. For example, if the lessee's interest in the real property is terminated before the expiration of the lease by lapse of time, the lienholder may exert his or her claim against the lessor but only to the extent of the lessee's forfeited interest. Where, however, the lessee's interest in the property expires by lapse of time, the lienholder may have no interest against which to operate. If the terms of the lease agreement require the lessee to construct a building that will increase the value of the property upon reversion to the owner, the improvements are for the lessor's benefit and a mechanic's lien will attach to the lessor's interest in the real property. In the court's decision in Campbell & Summerhays, Inc. v. Greene,5 the owner of a tract of land executed a lease agreement that, in part, required the lessee to construct a building on the property to be used as a funeral home. Although the lessee began construction on the building as stated within the lease, the lessee soon ran out of money. As a result, the lessee failed to make any further rental payments under the lease, causing the lessor to deem the lessee in default of the lease. At the time of default, the building was only partially completed, and several claims had been made by subcontractors and material suppliers to the project. The question presented to the court was whether perfected mechanics' liens on the building were enforceable against the lessor's ownership interest in the property or only against the lessee's forfeited interest in the leasehold. The court held that the provisions in the lease requiring the building to be built essentially amounted to the lessor contracting for the improvement for his or her benefit. As such, the lien claimants were entitled to assert their liens against the lessor's freehold interest in the property.

5 381 S.W.2d 531 (Ky. App. 1964).

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Theoretically, the owner of a private construction project can be made to pay twice for the improvements made on the property: once to the general contractor and another time to the subcontractor or material supplier claiming a lien, should the general contractor fail to properly pay the subcontractor or material supplier. However, the Kentucky legislature has granted special consideration to those persons who contract for the building of single or double family homes intended for use as their own dwellings, for these individuals are generally considered to be less sophisticated on matters dealing with the construction industry. Subcontractors and material suppliers on these construction projects acquire a mechanic's lien for the labor or materials furnished to the improvement, but that lien is not enforceable to the extent that the owner has already made payments for work performed or materials furnished. This subsection of the statute assures that the owner of a single or double family dwelling will only have to pay for the labor performed and materials furnished one time, and it protects the owner from the inequity of liens that surface after the owner has paid the contractor in full.

b. Public Projects

A mechanic's lien does not attach to and cannot be enforced against public property acquired and used by and for the benefit of the public. It would be against public policy to permit public property to be sold in satisfaction of a private debt. Instead, a mechanics' lien on a public project will impound earned unpaid contract funds in the hands of the public agency that is contracting for the improvements. Section 376.210(1) of the Kentucky Revised Statutes provides, in relevant part:

Any person, firm or corporation who performs labor or furnishes material or supplies for the construction, maintenance, or improvements of any canal, railroad, bridge, public highway or other public improvement in this state by contract, express or implied, with the owner thereof or by subcontract thereunder shall have a lien thereon, and upon all the property and the franchises of the owner, except property owned by the state, a subdivision or agency thereof, or by any county or city. If the property improved is owned by the state or by any subdivision or agency thereof, or by any county or city, the person furnishing the labor, materials or supplies shall have a lien on the funds due the contractor from the owner of the property improved.

The mechanic's lien in these cases attaches only to funds actually earned by the contractor and does not attach to funds that are unearned. Therefore, when a contractor is paid for all of the work performed, several weeks before any liens are filed by subcontractors or material suppliers, there is nothing to which a lien can attach.

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2. RIGHT TO A MECHANIC'S LIEN

a. Nature of Improvement

Since the right to a mechanic's lien is dependent upon statute, the determination of to which types of improvements a mechanic's lien may attach involves strict statutory interpretation. KRS 376.010(1) provides a comprehensive list of the improvements to which a mechanics' lien may attach, as well as the catchall phrase "for the improvement in any manner of real property." In this context, an improvement can constitute just about anything that enhances the value of the land.

b. Nature of Services Rendered and Materials Furnished

Lienable entities generally fall into two primary categories: (1) the performance of work or labor; and (2) the furnishing of materials, equipment and/or machinery. This is important for one who does not furnish labor or materials but only furnishes money, capital equipment or the plant of a contractor is not entitled to a mechanic's lien.

c. Labor

KRS 376.010(1) expressly provides that labor may form the basis of a lien against the property upon which improvements are made. The terms of the statute shall be strictly construed, and coverage under the statute will only extend to those services that are specifically set out in the statute. However, it is not necessary that the labor be actually performed on the improvement itself as long as the labor was necessary to the improvement.

d. Materials

KRS 376.010(1) has been construed to grant a mechanic's lien to all persons who provide various materials as ordinarily used in the construction of buildings or other structures, and whose use is expressly or impliedly contained within the terms and conditions of the contract between the owner and the contractor. In addition, a mechanic's lien may be acquired for material furnished to the job site that has not been incorporated into the improvement so long as the material has actually been delivered to the job site. A right to a mechanic's lien also exists for material delivered to the contractor that has not been delivered to the job site, where the material was delivered at the expense of the material supplier at a place agreed upon, accessible, and convenient for use by the contractor or owner. However, if the materials are delivered to a contractor after the owner has terminated the contract with the contractor, there can be no mechanic's lien for the material supplied. The U.S. Court of Appeals for the Sixth Circuit has held that in order to sustain a valid mechanic's lien, it is sufficient for a subcontractor or material supplier to show that materials adapted for use in the structure or building were furnished or delivered in good faith for incorporation into the

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structure or building, even though the materials do not become part of such improvement. The rationale for this position, aside from the fact that the statute explicitly states that a lien is available to one who simply "furnishes" materials, is primarily the hardship that would follow the adoption of the contrary view; namely, the material supplier must prove an actual use of the material in the construction. But, if the failure to use the materials in the structure or improvement is due to the fault of the material supplier, the material supplier does not have the right to possess a mechanic's lien.

e. Temporary or Falsework Use

A mechanic's lien may also exist for material suppliers who furnish materials used in temporary processes, especially if in such process the material is consumed entirely or destroyed. For example, a lien will be allowed for the full value of lumber or any other material purchased and used for constructing concrete forms that were consumed or rendered useless by such use. It is not presently clear the position the Kentucky courts would take should the concrete forms in this example not be destroyed in their use, but rather depreciate in value; some jurisdictions have held that such forms become part of the contractor's equipment against which a mechanic's lien may not attach. KRS 376.010(1) contemplates a contract or agreement with a material supplier that is more specific than an ordinary sale of materials. It should be understood between the parties that the materials are furnished for a purpose named in the statute. If materials are sold under an ordinary sale on credit or an open account, even though the buyer may actually use them in a building or improvement, no mechanic's lien will attach. Articles furnished for use merely as tools or equipment and not incorporated into the improvement that survive yet are incapable of further use by the contractor on other projects, even though they are used in carrying on the work of construction of improvement, are not material for which a mechanic's lien may be claimed. The same is true of machinery furnished to the contractor for use as a party of its plant or operations. Finally, clothing, shelter, and groceries furnished to the employees of a contractor and consumed by his or her employees do not come within the purview of KRS 376.010(1).

f. Fixtures

Fixtures or machinery included in the improvement are included within the list of improvements to which mechanics' liens may attach. "Fixtures" are goods that become so related to particular real estate that an interest in them arises under real estate law. One of the basic reasons for the preference provided by the mechanic's lien statute is that the labor or materials provided for the improvement of the real property have been so incorporated into that property that they are placed beyond recovery or possession. This does not apply to a manufacturer or dealer who supplies an appliance or machine that never loses its identity or becomes an integral or necessary part of the building.

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For purposes of the mechanic's lien statute, only property permanently incorporated into the structure should be deemed a fixture. Any goods that can be readily removed from the structure without damage to the goods or the building are not considered fixtures, and therefore are not subject to the mechanic's lien statute. Likewise, machinery which is removable from the structure without damage to the machine or the building is not permanently incorporated with the building, does not become a part of the real property, and is not subject to the protections afforded by KRS 376.010(1).

g. Rental Equipment

Historically, Kentucky law did not grant mechanic's lien rights for rental equipment used on private improvement projects. For example, Kentucky Courts have held that the lessor of equipment to either a contractor or a subcontractor is not entitled to a mechanic's lien under the statute which confers the lien only for work done and materials furnished in building, construction, or improvement of land. However, in May 1992, the Kentucky Court of Appeals held that KRS 376.010 does provide a mechanic's lien to secure payment of rental charges to the lessor of equipment and machinery. To coincide with the findings of the Court of Appeals, the Kentucky General Assembly amended the mechanic's lien statute in 1994 so that a person now has lien rights for the reasonable rental price of equipment and machinery used in performing work to improve private property. In comparison, public improvement projects have long recognized that charges for rental equipment may form the basis of a mechanic's lien on a public project. The rental price must be either agreed upon by the parties, or, if the price is not agreed upon, it must be reasonable. In no case may the rental charges exceed the value of the equipment.

h. Off-site Improvements

There is currently no Kentucky case law addressing whether off-site improvements to property may form the basis for a mechanic's lien on the property itself. The language of KRS 376.010, however, appears to contemplate that a lien may attach to real property for such improvements where those improvements have a physical or beneficial connection with the real property. Mechanics' liens have even been allowed in other jurisdictions against property for pipes laid in the street right of way and connected to the property. However, if the improvement is not connected with the construction, erection or alteration of a structure, a claim for the improvement alone is likely to be rejected. For example, Pennsylvania Courts have held that the excavation, grading, clearing, and installation of storm sewers were not lienable as no building or permanent structure was erected in connection with the services provided by the claimant.

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3. NECESSITY OF WRITTEN CONTRACT OR CONSENT OF OWNER A mechanic's lien may be asserted only where there is a valid contract directly or indirectly with the owner of the real property or some estate or interest in the real property to be subjected to the lien or where labor is performed or materials furnished with or by the owner's consent. The statute creates the lien only if there is a contract to support it. Accordingly, if the negotiations are not complete for want of acceptance and consent of the owner, the agreement is too indefinite and uncertain, no debt is created by the agreement, or services are voluntarily performed without express or implied promises of payment by the owner, there can be no lien asserted by the supplier. The contract with the owner is just as essential to the lien of a subcontractor or material supplier as it is to the lien of the contractor. The right to a mechanic's lien is not confined to persons contracting directly with the owner of the property or performing labor or furnishing material with the actual knowledge of the owner but extends to persons who do work and furnish materials under contract with one who contracted with the owner. An owner, by contracting for construction or improvement of its property, impliedly consents that the contractor should take such reasonable steps as necessary to complete the work and thereby consents to the furnishing of labor and materials by others at the contractor's request.

4. PERSONS ENTITLED TO A LIEN a. KRS 376.010 is quite comprehensive as to the persons entitled to a

mechanic's lien, referring to "any person" performing particular types of work or furnishing material. Whether a particular person is entitled to a lien under the statute depends upon the type of improvements being made and the terms and conditions of that person's involvement in the project. A contractor is entitled to a mechanic's lien on private projects. Although the statute does not preclude a mechanic's lien for contractors on public projects, the practical effect of the application of the statute merely gives the contractor lien rights in the funds which the public owner is obligated to pay to the contractor anyway.

b. Subcontractors and material suppliers are granted mechanics' liens on

both private and public projects. The statute, however, does not confer a lien on a material supplier who furnishes material to another material supplier. The materials must be furnished to the "owner, contractor, subcontractor, architect, or other authorized agent" before the person furnishing the supplies will have mechanics' liens rights.

c. Under the express language of KRS 376.075, engineers and land

surveyors have lien rights to protect their right to payment. This protection was extended to architects and landscape architects as well in 1992. The statute requires that the engineer, architect, landscape architect, or land surveyor have a direct contract with the owner or his or her agent in order to be vested with lien rights. An engineer serving as a consultant to an architect does not have lien rights. The statute expressly provides that an

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engineer or land surveyor contracting with a public owner has mechanics' lien rights. However, just as with a contractor who contracts directly with a public owner, the engineer or land surveyor acquires lien rights only in the funds which the public owner is obligated to pay anyway.

5. PERFECTING A MECHANIC'S LIEN

As stated previously, the statutory provisions for perfecting a mechanic's lien in Kentucky are very complex and require strict attention to detail. It is safe to say that an unpaid contractor, subcontractor, or material supplier attempting to assert a mechanic's lien must strictly adhere to the statutory requirements or it risks losing its lien rights altogether.

a. Private Projects

Preliminary Notice – Notice to the Owner

Only persons that do not contract directly with the property owner or agent – that is, a subcontractor or material supplier who deals with the contractor or another subcontractor and whose existence may be unknown to the owner -- must comply with the statutory provisions requiring written notice of their claim be sent to the owner. The purpose of requiring this notice to the owner is to advise the owner of the nature and amount of the claim so that he or she may protect himself or herself in future dealings with the person with whom the lien claimant contracted and, particularly, to enable the owner to retain whatever money may be due the contractor and apply it to the payment of the lien claimed. Conversely, such preliminary notice to the owner is not required when the labor or material is furnished on the order of the owner or agent, for the owner is presumed to already be put on notice of the potential claim of the lienholder. The preliminary notice requirement must be "substantially followed" in order to acquire a valid and enforceable mechanic's lien. Despite this mandatory notice requirement, a subcontractor's or material supplier's lien rights are in no way diminished or threatened if, at the time the services are performed or materials are furnished, the subcontractor or material supplier did not know who was the improvement's owner. Written notice of intent to file a mechanic's lien must comply with the following statutory guidelines:

(1) It must be in writing; (2) It must be delivered to the owner within the statutory time limits; (3) It must adequately inform the owner of the lienholder's intent to

hold the property liable; and

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(4) It must affirmatively state the precise amount for which a mechanics' lien will be claimed.

Although not required by the statute, it is good practice for the lienholder, be it a subcontractor or material supplier, to provide a copy of the notice of intent to claim a mechanic's lien to the general contractor, as well. Service of the preliminary notice upon the owner or authorized agent may be made by mailing that notice to the last known address of the owner of the property, whether an owner-occupant or otherwise or to the duly authorized agent. Although not required, it is good practice to send this notice via certified and regular first-class mail to ensure receipt by the owner. The time limit within which this notice must be given to the owner depends upon the nature of the project and the amount of money being claimed. For improvements to an owner-occupant's single or double-family dwelling, written notice must be given to the owner or authorized agent not more than 45 days after the last item of material or labor is furnished. For all other improvements to privately-owned real property, written notice must be given to the owner of the property or authorized agent within 75 days on claims amounting to less than $1,000 and 120 days on claims in excess of $1,000 after the last item of material or labor is furnished. It should be noted that this preliminary notice, when required, must be given prior to the filing of the statement of lien or the initiation of litigation to enforce the lien. A lien statement or complaint properly filed and served on the owner of a property within the statutory time period does not substitute for the written notice required by the statute.

i. Filing Statement of Lien

In order to perfect a mechanic's lien, the lien claimant must file a sworn statement of lien within the statutory time frame. This requirement is independent of the preliminary notice of intent which must be given to the owner of the real property. The lien statement is neither a process, pleading, judgment or conveyance but merely a notice of the claim. Its purpose is to provide prospective purchasers of the property notice of the amount and nature of the lien to which the property is subject and in whose favor the lien has accrued.

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ii. Time for Filing

The lien statement must be filed within six (6) months after the last labor or materials were furnished to the project by the claimant. Should the claimant fail to file its lien statement within this time period, it effectively waives its lien rights for that particular project. "Punch list" work or other minor finishing work done at the request of the owner may extend the time limits in which a claimant must file a lien statement. However, this period cannot be prolonged by furnishing labor or materials that are trivial and unnecessary for the completion of the contract, nor can it be extended as a result of work on warranty items.

iii. Form and Content

The lien statement must include the following items in order to comply with the provisions of KRS 376.080(1):

(1) The name and current address of the claimant; (2) The legal name of the owner of the property, if known by

the claimant; (3) The amount currently due and owing the claimant, along

with all just credits and set-offs known to the claimant at that time;

(4) The manner by which the materials were furnished or the

labor performed by the claimant (i.e. whether it was through a direct contract with the owner or a contract with a contractor or subcontractor);

(5) The date on which the last item of work was completed by

the claimant; (6) A legal description of the property intended to be covered

by the lien, sufficiently accurate to identify the subject property; and

(7) If the claimant is a corporation or other business form, its

official agent for service of process, or some other address at which proper service may be accomplished pursuant to the Kentucky Rules of Civil Procedure (however, it should be noted that if no name and address is included in the lien statement, service of process in any action involving the subject property may be accomplished by serving the person who signs the lien statement).

Another statutory requirement regarding the form of the lien statement is that it must be "subscribed and sworn to" by the claimant or by someone on his or her behalf. The importance of

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this requirement was evidenced in the court's decision in Hubb City Wholesale Electric, Inc., v. Mik-Beth Electric Co., Ltd.6 In Hubb City, a notary public's acknowledgement on an otherwise valid lien statement did not contain the words "sworn and subscribed to." Because it failed to contain this statutory language, the lien was held to be invalid.

iv. Place for Filing

The completed lien statement must be filed with the county clerk of the county in which the building or improvement is located, together with a filing fee as prescribed by KRS 64.012.

v. Amendment of Lien Statement

A lien statement previously filed with the county clerk may be amended or corrected at any time within the six (6) month statutory time period. The amended or corrected lien statement then becomes the original statement, and any time periods which are based upon the filing of the lien statement commence with the filing of the corrected or amended statement. However, after the time for filing the lien statement has elapsed, an incorrect lien statement may not be cured, either by amendment or otherwise.

vi. Filing One or More Lien Statements

It is a general rule that a lien statement must be filed for what was done or furnished under each contract within the statutory time period after completion of the contract work. Where labor or materials are provided for two (2) or more buildings under one contract and for one owner, one lien statement may be filed covering the separate buildings. The statement must be filed within the statutory time period after completion of the last building or the furnishing of the last item of work or material, even though the statement may not be filed within the statutory time frame after completion of other buildings against which the single lien is asserted. Conversely, where labor or materials are furnished under separate contracts, separate lien statements must be filed. After a contract is completed and closed, the time for filing a lien statement cannot be extended or the right revived by furnishing material or performing labor upon a new contract and tacking such items on to the original contract.

6 621 S.W.2d 242 (Ky. App. 1981).

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vii. Notice of Filing

Upon completion of the lien statement, the lien claimant is required to send a copy of the lien statement to the property owner within seven (7) days of filing the statement of lien with the county clerk. The failure to provide a copy of the lien statement to the property owner shall cause the claimant's lien to be dissolved. The required method of delivery of the lien statement under the statute is vague in that it states that the statement of lien should be sent "by regular mail." Therefore, to comply with the statute and have a record that a copy of the statement of lien was sent to the owner, it is good practice for the lien claimant to send the lien statement to the owner both by regular mail and by certified mail. It is this part of the statute that most attorneys fail to satisfy.

b. Public Projects

Preliminary Notice – Preliminary Lien Statement The preliminary notice of an intent to file a mechanic's lien is not required to be given to the owner of a public project like it is for a private project as one cannot hold a lien on property designated for public use. As a lien on a public project attaches only to the funds in the owner's hands that are owed to the contractor, there is no danger of the public owner having to pay twice for particular work. However, KRS 376.210(2) still provides for a preliminary notice nevertheless. This notice is a preliminary statement of lien which is filed with the county clerk in the county where the seat of government of the public agency that owns the property improved is located. The purpose of the preliminary lien statement is to put other potential lien claimants on the improvement project on notice of the filing party's intent to claim a lien. This statement does not create a lien; it merely establishes the priority among the liens filed on the project. It is not fatal to a party's claim if a preliminary lien statement is not filed as long as the statement of lien called for in KRS 376.230(1) is timely and properly filed. However, failure to file the preliminary lien statement can be fatal to a claim for priority.

In order to properly protect their mechanic's lien rights on public projects, subcontractors and material suppliers should, as a matter of course, file a preliminary lien statement for every public project for which they will furnish labor or material. This preliminary statement should be filed as soon as the subcontractor or material supplier signs a subcontract or receives a purchase order. The preliminary lien statement should state that the claimant expects to provide labor and/or materials to the project. The statement should also include the price for which the labor and/or materials will be furnished. Any labor or materials the claimant furnishes will relate back and take effect from the date the preliminary lien statement is filed.

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i. Filing Statement of Lien

Just as on a private project, a mechanic's lien claimant on a public project must file a sworn statement of lien. The lien does not attach unless this statement is filed.

ii. Time for Filing

The lien statement must be filed within thirty (30) days after the last day of the last month in which any labor or materials were furnished or prior to the date of substantial completion whichever is later. Just as with a private project, the time period for filing the lien statement cannot be extended by furnishing trivial or unnecessary labor or materials or by doing warranty work.

iii. Form and Content

The lien statement for a public project must include the following information:

(1) The amount due for which the lien is claimed; (2) The date on which the last labor or materials were

furnished; and (3) The name of the public improvement upon which the lien is

claimed.

The lien statement must be verified by an affidavit of the claimant or an authorized agent or attorney. Although the statute does not require that the lien statement or the affidavit be "subscribed and sworn to," good practice would dictate that this language be used.

iv. Place for Filing

The completed lien statement must be filed with the county clerk of the county in which the seat of government of the owner of the property is located together with a filing fee as prescribed in KRS 64.012.

v. Perfecting the Lien

After the lien statement has been filed, the claimant must perfect the lien by filing an attested copy of the lien statement with the owner of the public improvement together with a signed copy of a letter addressed to the contractor or subcontractor with whom the claimant was in privity with a post office receipt showing that an attested copy of the lien statement was sent to that contractor or subcontractor.

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