NY Supreme Court upholds design-build contract

Real Estate Weekly, July 21, 1993 by Susanna S. Fodor, Fredrick E. Sherman

Project owners were the victors recently when the New York Supreme Court ruled against a surety that sought to avoid its obligations under a performance bond by claiming that the bonded design-build contract was illegal. The bonded contract was for the provision of the curtainwall enclosure on a major building project in New York City's downtown financial district.

The decision is on appeal to the Appellate Division.

The surety had sought to dismiss the project owner's claim for payment on the bond by moving for summary judgment on the ground that the contract violated the engineering provisions of the New York Education Law and the curtainwall regulations of the New York City Building Code. It argued that the curtainwall contract violated the state law and the city regulations because it called for performance of certain engineering functions by the contractor responsible for constructing the curtainwall.

The court denied the motion for summary judgment on alternative grounds. The surety had failed to plead the illegality defense in its answer and the court held that the defense was not "properly raised" on the motion for summary judgment. The court also ruled that the delegation of design responsibilities provided for in the curtainwall contract did not violate either the Education Law or the City Building Code.

In denying the surety's motion, the Court relied on the landmark decision upholding the legality of design-build contracts, Charlebois vs. J.M. Weller Associates, Inc., 72 N.Y.2d 587, 535 N.Y.5.2d 356 (1988), which the Court described as "the most recent guiding pronouncement on the subject of engineering services in a construction contract." In Charlebois, the plaintiffs were property owners who brought an action against a contractor who had constructed a new warehouse and addition on the plaintiffs' commercial property. The owners, in an effort to avoid paying for the work, sought a declaration that the design/build contract was invalid as in violation of the State Education Law and the Court denied the relief.

The Charlebois Court pointed out that the property owners, who had not alleged that any of the engineering work under the contract was defective, should not be allowed to use the Engineering Law as a means of avoiding paying the contractor for

The recent decision involved an unusual use of the illegality defense, in addition to being the first time that a surety has asserted the defense, at least in New York State. In prior cases the defense was generally used by owners being sued by contractors or design professionals seeking payment for work that they performed. In the case in which the recent decision was rendered, that usual scenario was turned around. The surety, standing in the shoes of the contractor, attempted to use the defense against a property owner.

The surety's use of this defense has important practical implications for property owners entering into agreements with sureties on design-build contracts. For example, it would be advisable for the obligees under the bond to notify the surety in writing of the fact that the contract that will be covered by the performance bond requires the contractor to perform some engineering services in connection with the work.

In addition, the contract should require that the engineer performing the design functions be designated as the "engineer of record" for the portion of the work that the engineer is responsible to design. The engineer should also be licensed in New York State.

Finally, the design-build contract and the other project-related agreements should provide for checks and balances to ensure that there is review of the engineering work performed pursuant to the design-build contract. Particular attention should be given to such issues as controlled inspections, shop drawing review and approvals, and liability for design.

The decision is an important development on the issue of the legality of design-build contracts, which have been the subject of some disturbing legal attacks in recent years. The challenges to the legality of these contracts have appeared in New York and other states as contractors in specialized areas have emerged to supply high-technology services such as curtainwalls. The use of design-build contracts for such high-technology services is common throughout the United States and is intended to ensure that the services are provided by persons with the greatest possible specialized expertise in the particular area. The danger of attacking these contracts has been pointed out frequently by associations for the construction trades, construction lawyers and others in the field.