When Substitutions Go Wrong

The COVID-19 pandemic caused shortages in material and labor, resulting in rising prices and project delays. A poll from the Association General Contractors of America indicated that 88% of firms are experiencing project delays, and 93% are affected by rising material prices. According to the director of The Boeing Center for Supply Chain Innovation at Washington University in St. Louis, supply chain disruptions are likely to continue through mid-2022.

During World War II, a lack of materials and labor drove General Electric Co. employees to look for solutions to address these scarcities. The employees concluded that specified materials and services could be substituted when the same function and characteristics are provided by a cheaper or more available replacement. The process that identifies and incorporates acceptable substitutions into a project has become known as value engineering and is now prevalent in both private and public construction projects. In fact, the Federal Acquisition Regulations provide a process allowing a contractor to share in the savings created by value engineering.

The ongoing issues with the supply chain and labor shortages will likely result in value engineering being used more often to overcome these industry problems. Even though value engineering is frequently utilized without any problems, its use can create potential liability for architects, engineers, contractors, construction managers, and suppliers when a value-engineered substitution is identified as the cause or a contributing cause of a failed project.

Who’s at Fault?

Evaluating a claim involving value engineering begins with a thorough review of the contract documents to determine whether liability arising from value engineering was addressed. Contract documents may specifically state that certain parties (the owner, project manager, or designer) are not liable for damages arising from value engineering. Enforceability of such provisions will be based upon the laws governing the contract. For example, in Purcell Tire & Rubber, Inc. v. Exec. Beechcraft, Inc., the Missouri Supreme Court held sophisticated parties may contractually limit future remedies. Absent a contractual provision addressing this issue, potential liability will be based on the applicable state’s substantive law.

Claims arising from value engineering may be asserted against a design professional whether or not she specifically recommended the particular substitution at issue. For a design professional who recommended a substitution, a claimant will need to prove the substitution was the proximate cause of the alleged damages and the elements of the specific claim being asserted, such as professional negligence or breach of contract.

Alternatively, design professionals without any construction administration responsibilities are not liable for plan deviations that are the proximate cause of a project’s failure, as demonstrated by the Minnesota Court of Appeals case, Goette v. Press Bar and Cafe, Inc. But claimants attempt to avoid the consequences of this longstanding principle of law by showing a design professional was aware of a value-engineered substitution and is, therefore, responsible.

For instance, in the First Circuit case of American Employers’ Insurance Co. v. Maryland Casualty Co., the city retained an architect to design and prepare plans and specifications for a project. A construction firm was then retained to value engineer the project, and it changed the architect’s plans that were ultimately used for bidding and awarding a contract.

After problems with the constructed building arose, the city filed a lawsuit against not only the construction firm, but also the architect. The city’s lawsuit alleged the architect was liable, in part, for being “negligent in agreeing to and acquiescing in the aforesaid changes advised by [construction firm].” This fact pattern illustrates how design professionals may be alleged to be responsible for changes they neither recommended nor incorporated into the approved plans or specifications. Similarly, design professionals may find themselves defending against subrogation claims in which other parties’ carriers attempt to recover amounts paid on value engineering claims by alleging design issues, even when the design professional neither approved nor acquiesced in a value engineered substitution.

Just the Facts

Evaluating a design professional’s potential liability under these scenarios requires an in-depth examination and understanding of the value engineering process used and the parties involved. This begins with identifying who requested the substitution, whose behalf were they acting upon (the owner, construction manager, or contractor), who realized the savings, who implemented the substitution, and who knew the substitution had been made.

Simultaneously, the design professional’s conduct and involvement must be carefully examined. Important factual information includes whether the design professional specifically approved the substitution, knew about the substitution, or updated any plans or specifications as a result of the substitution. Equally important is whether the design professional had worked on prior projects with those involved in the value engineering process, and, if so, what custom and practice had been established and previously used during the value-engineering process. This factual information will provide the framework for the design professional’s defense, and identify others involved in the process who may arguably be jointly liable for the alleged failure.

Suppliers may also be liable for the alleged failure of a substituted material. Knowing that owners and contractors are always in search of cheaper materials, material suppliers may represent or warrant that their own branded product or another product they sell meets the specifications and characteristics of a product identified in the project’s specifications, or is an equivalent. A supplier making such representations may be liable if those representations are false.

For instance, in the Tennessee Court of Appeals case Tolley & Lowe Painting Contractors, Inc. v. Grinder & White Equip. & Supply Co., Inc., a supplier was held liable for damages arising from the failure of the caulk it sold because it made assurances to the project’s owner and contractor that the caulk “met the required specifications.” Therefore, any time a particular building material is at issue, communications with the supplier should be obtained and examined to determine if there are any potential claims for breach of an express or implied warranty, breach of contract, or misrepresentation.

Value engineering may reduce the impact of the current supply chain issues, but it may also generate claims against those involved in the project based on theories that have been relatively uncommon. Underwriters may want to confirm whether insureds’ contract documents address value engineering and whether they include any transfer or limitation of the risks involved.

For professionals defending against such claims, a review of the contract documents and material specifications, along with an in-depth examination of the process that resulted in the alleged improper substitution, will provide the foundation of the defense.