by Scott P. Fitzsimmons, Associate

Sending a stark message to contractors, the Supreme Court of Virginia recently held that an owner’s damages for defective construction may considerably exceed the original contract amount.  Nichols Constr. Corp. v. Virginia Machine Tool Co., LLC, 276 Va. 81 (2008).  In Nichols, the Court reaffirmed Virginia’s “cost rule” of calculating construction damages and rejected application of the “value rule” in that particular case.  Under the “cost rule,” the court may award the full cost of repairing defective construction as long as the cost is reasonable.  If the “cost rule” would involve economic waste, a court instead applies the “value rule.” Under the “value rule” the court awards the difference between the value of the structure properly completed and the value of the defective structure.

Under both the “cost rule” and “value rule” the contractor has the burden of rebutting the owner’s alleged damages.   In Nichols,  the Court found that the contractor, Nichols Construction, failed to challenge the reasonableness of the owner’s damages or  otherwise prove the diminished value of the property.   As a result, the Court had no choice but to apply the “cost rule” and award the owner more than three times the contract amount in damages.  The Court’s decision in Nichols serves as a blunt reminder to contractors regarding their responsibility to refute an owner’s alleged damages, and highlights the costly result in failing to do so.

Background

In Nichols, the parties entered into a contract, prepared on a standard American Institute of Architects (“AIA”) form, for the installation of a flat roof on an industrial building.  The contract also required reinforcement of the building’s structural walls to support the new roof, and additional renovation of the building.  The contract required the installation of a prefabricated roofing system manufactured by a specific supplier. 

The parties agreed that the portion of the contract related to the roof installation was approximately $140,000.   The parties also agreed that the contract precluded the recovery of consequential damages in the event of a breach of the contract.  As work progressed, the owner, Virginia Machine Tool, became dissatisfied with the quality of work performed by the contractor.  It became evident that the roof was sagging and consequently water was not properly draining from the roof.  Despite the contractor’s attempt to remediate the defective construction, problems with the roof persisted.  Ultimately, the parties determined that the prefabricated roof system was defective.

Completely dissatisfied with the contractor’s efforts, Virginia Machine barred Nichols from completing the final phase of the project, refused to allow any further remedial efforts, withheld final payment on the contract, and brought suit against Nichols for more than $450,000, the estimated cost of removing and replacing the entire roof system.

At trial, the owner, Virginia Machine, presented testimony regarding the cost to repair the defective roof and argued that the roof needed to be completely removed and replaced. The owner estimated that cost to be $450,842. Conversely, Nichols argued that the owner was entitled to recover only the value of the original contract - $140,000. Nichols further disputed the owner’s estimate for replacing the defective roof as inaccurate and resulting in a windfall to the owner. In short, Nichols argued that Virginia Machine “had contracted for a Chevy of a roof but wants that replaced with a Cadillac.”

Despite arguing that Virginia Machine’s recovery was limited to the contract amount, Nichols failed to cite any relevant authority, failed to present any evidence rebutting the owner’s estimate, and failed to establish that the replacement roof was markedly superior to the roof for which Virginia Machine had originally contracted. Nichols also failed to provide any evidence whatsoever regarding the diminished value of the property.

Based upon the evidence presented by Virginia Machine, and the lack of evidence regarding the diminished value of the property, the trial court had no choice but to apply the “cost rule” of calculating construction damages.  As a result, the court entered judgment against Nichols in the amount of $450,842, representing the owner’s estimate to completely replace Nichols’ defective roof.

Analysis on Appeal

On appeal to the Supreme Court of Virginia, Nichols argued that the damage award placed Virginia Machine in a better position than it would have enjoyed had the contract been performed as expected.  Nichols further argued that under either the “cost rule” or the “value rule,” the damages awarded were excessive as a matter of law.

To support its arguments, Nichols first pointed out that the contract required the installation of a $140,000 roof, and excluded the recovery of consequential damages.  Nichols further argued that the contract required the installation of a specific brand of roof and that Virginia Machine was not awarded damages for that brand but, rather, for a different roof system.  Finally, Nichols argued that Virginia Machine was awarded the cost to fully replace the defective roof, rather than the cost of repair, and that the amount awarded was more than twice the value of the building, including land and equipment.

The Supreme Court began its analysis by recognizing the considerable disparity between the contract amount and the damages awarded.  The Court acknowledged that the difference was, initially at least, facially compelling evidence in support of Nichols’ position that the award resulted in a windfall to Virginia Machine.  Ultimately, however, the Court was not persuaded to reverse or modify the trial court’s ruling.  Instead, the Supreme Court upheld the trial court’s conclusion that the defective roof needed to be completely replaced with a new roof.  Because Nichols failed to rebut the owner’s damage estimate, it never established that repairing the defective roof was a reasonable option to full replacement.

The Supreme Court held that the contractor, Nichols, was required to offer competent evidence either that the cost of replacement was less than Virginia Machine contended, or that awarding cost damages would be grossly disproportionate and result in economic waste.  In the absence of such proof, the trial court would have been required to resort to speculation and conjecture in order to find that applying the “cost rule” was not the appropriate remedy.

In this case, Nichols failed to produce sufficient evidence to overcome Virginia Machine’s prima facie case regarding damages.  As a result, the Supreme Court, like the trial court, had no choice but to reject the “value rule” and uphold the “cost rule” against Nichols.

Conclusion

The Supreme Court’s decision in Nichols warns contractors regarding two critical aspects of litigating construction claims.  First, a contractor must be prepared to rebut and defend against an owner’s alleged damages.  Failure to do so may result in application of the “cost rule” to the extreme detriment of the contractor.  Second, a contractor must recognize that damages for defective construction may greatly exceed the contract price. Indeed, even on a small project, an owner who pays for a Chevy may be entitled to a Cadillac if the contractor defaults.


The information or opinion provided in this article is the author's own and not necessarily that of Watt, Tieder, Hoffar & Fitzgerald, LLP. The author is solely responsible for the information and opinion that he or she has provided. The information contained herein does not replace seeking specific legal counsel to directly address individual client needs.

Watt, Tieder, Hoffar & Fitzgerald is one of the largest construction law firms in the world, with a practice that encompasses all aspects of construction contracting, claims and disputes resolution, and transactional legal services. WTHF principally represents large general contractors, design firms, and sureties throughout the country and internationally.