The Risk of Long-Lead-Item Expenses

By John S. Mrowiec

On privately owned construction projects, it has become increasingly common for contractors to begin ordering long-lead items of materials and equipment before the owner has obtained a building permit.

Care is warranted. Who bears the risk of payment for those "long-lead items" if the permit is not issued and the project ultimately does not proceed?

An example of such a dispute is Otis Elevator Co. v. Fulcrum Construction Co., 2006 Wis. App. LEXIS 661 (Dist. One, July 25, 2006).

Medical Office Project

On Dec. 8, 1999, Fulcrum Construction Co., as general contractor, signed a contract to construct a medical building for Capital Medical Development LLC, the owner. Prior to entering into the contract, the contractor had negotiated with Northwestern Elevator Co., a predecessor of Otis Elevator Co., for the supply and installation of a hydraulic passenger elevator based on Sept. 17, 1999, elevator drawings supplied by the owner's architect.

By a Nov. 23, 1999, letter, the elevator subcontractor advised that the elevator components had to be ordered 16 weeks prior to installation, asked whether the architect's drawings had changed in the interim and requested that contractor sign an enclosed Elevator Ordering Information form.

The contractor did not sign the Elevator Ordering Information form, but the Architect did on Dec. 21, 1999. On Jan. 25, 2000, the contractor and elevator subcontractor entered into a written subcontract.

The subcontract incorporated the General Conditions of the general contract.

Based on the quotations of the General Conditions in the Fulcrum Construction decision, the General Conditions appear to be the American Institute of Architects form.

On Feb. 3, 2000, one week after entering into the subcontract, the elevator subcontractor ordered elevator components to meet the required installation date of June 6, 2000. On March 15, the contractor notified all subcontractors that, because of a problem obtaining a building permit, the project had been suspended. The contractor's notice to the subcontractors expressly stated that the project was "not terminated."

On April 12, 2000, the elevator subcontractor submitted shop drawings and advised that it could not apply for an elevator permit without approval. The shop drawings were never approved. (The Fulcrum Construction decision does not state whether the shop drawings were rejected.)

On May 18, 2000, the elevator subcontractor invoiced the contractor for the elevator components. The contractor refused to pay contending that contractor had advised that no components should be ordered without approved shop drawings. The owner canceled the project. (The decision again is unclear on whether owner's cancellation preceded contractor's letter with the "no approved shop drawing" rationale for non-payment.)

Elevator Contractor Sues

The elevator subcontractor sued the general contractor. The contractor relied on Section 3.12.7 of the General Conditions:

"The [Subcontractor] shall perform no portion of the Work for which the Contract Documents require submittal and review of Shop Drawings, Product Data, Samples and similar submittals until the respective submittal has been approved by the Architect."

The Fulcrum Construction decision says "the specific shop drawings required for the elevator were described in detail in the four pages of the Project Manual" devoted to the elevator specifications (Fulcrum Construction, 2006 Wis. App. LEXIS 661, *17).

The contractor moved for summary judgment that no amount was owed to elevator subcontractor for the elevator components. The elevator subcontractor agreed that it was a responsible to submit shop drawings to receive an elevator permit and prior to installation but not before ordering.

According to the elevator subcontractor, submission of product data was all that was required.

The trial court agreed with the contractor and dismissed elevator subcontractor's complaint. The elevator subcontractor appealed.

On appeal, the court reviewed the Contract Documents and found them to be ambiguous. The Fulcrum Construction court believed 3.12.17 of the General
Conditions reasonably could be read to require approval of shop drawings prior to ordering of components, as the contractor contended, or merely approval of product data submissions prior to ordering and approval of shop drawings prior to installation, as elevator subcontractor contended.

The appellate court found a contradiction regarding the parties' intent in the evidence submitted on contractor's summary judgment. That created a question of fact that could not be resolved without a trial.

To determine which interpretation applied in this particular instance, the Fulcrum Construction trial court should consider at a trial "parol evidence" of the parties' conduct prior to entering into the written subcontract. Because a trial was necessary to determine the parties' intent, the trial court grant of summary judgment was reversed (Fulcrum Construction, 2006 Wisc. App. LEXIS 661, *18).

The Fulcrum Construction fact pattern is silent about some intriguing questions:

Did the owner pay general contractor a termination settlement? If not, was the contractor pursuing owner for payment?

(The 1997 edition of the AIA General Conditions provides the owner the right of "termination for convenience" with the obligation to pay for ordered or installed materials and equipment, among other things. The 1987 edition of those General Conditions does not address a convenience termination but, under that edition, the inability to obtain a permit might be an owner breach probably dependent on the Notice to Proceed language of the particular Contract.)

If the owner did pay a termination settlement, did the owner refuse to pay for the ordered elevator components? Did the four pages of specifications supposedly listing the required submittals distinguish between "product data" and "shop drawings" for elevator operating components?

When drafting contract documents or when ordering materials, parties should anticipate the possibility that the project might not proceed. Clarity regarding liability for payment in that event is important.

John S. Mrowiec is a partner with Chicago-based Conway & Mrowiec, a construction and public contracts law and litigation practice. He may be reached at (312) 658-1100. For information, go to the firm's Web site at www.cmcontractors.com.