September  13, 1996



Bulletin # 10: Warranty

The Malfunctioning Compressor

Acme Sheet Metal has been hired by a large general contractor to install an HVAC system in a new, five-star hotel. The air-handling system will be very elaborate and include a number of expensive chillers, compressors, and fans. In order to meet specifications, the "off-the-shelf" compressors that Acme would typically order will have to be substantially modified by the manufacturer. Acme has required that the manufacturer provide a one-year warranty.

The subcontract that Acme has signed with the general contractor is an AIA A-401 Contractor-Subcontractor Agreement, incorporating AIA A-201 General Conditions. Paragraph 12.2.2 of A-201 requires the general contractor to provide to the owner a one-year warranty after the date of substantial completion of the work or each designated portion of it. This obligation to provide the one-year warranty will "flow down" to Acme under Paragraph 1 - 1 of the subcontract.

Since Acme has required the one-year warranty from the manufacturer, it believes itself to be covered on its one-year warranty obligation to the general contractor. It accepts delivery of the equipment on April 1. The owner, general contractor, and Acme agree that Acme has substantially completed its work as of August 1 and final payment is made under the subcontract in late August. At the time of final payment, Acme assigns all of its equipment warranties to the owner.

In March of the following year, one of the compressors begins to emit a periodic thumping sound and a pressure drop is noted. The manufacturer is called and inspects the compressor, making some small adjustments. The sound and pressure drops occur intermittently over the next several months, but seem to resolve themselves on each occasion. The owner calls Acme when the equipment appears to be malfunctioning and Acme confers with the manufacturer, but no additional warranty work is performed on the equipment. On June 1 the compressor totally fails and, upon examination, is determined to have suffered severe internal damage that will require the replacement of a number of expensive components. The owner makes a claim on the manufacturers warranty for the damage. The manufacturer refuses the claim based upon the expiration of the one-year warranty period on April 1. The owner then brings a claim against the general contractor on its one-year construction warranty and the general contractor asserts a claim against Acme on its one-year subcontract warranty. Not having a manufacturer’s warranty to fall back on, Acme appears to be up the river without a paddle.

The Inherent Mismatch of Warranty Timetables

In almost all contracts, the warranty period for construction work will commence upon substantial completion of the work. If the project is divided into phases, substantial completion may occur as to a portion of the project (and the warranty may begin to run), even though other portions of the project may not be substantially complete. However, manufacturers’ warranties will almost always commence when the equipment is shipped or accepted by the purchaser. The typical equipment manufacturer’s warranty is one year or less. The typical construction warranty is one year and sometimes more. Since there will always be a time gap between the delivery of equipment and the substantial completion of a project, the subcontractor will face, at best, a period of several months during which it is required to warrant the operation of the equipment, but the manufacturer is not. The gap may be much longer, if the construction warranty period is substantially longer than the manufacturer’s warranty period.

There are several ways that a subcontractor can attempt to deal with the timing problem on equipment warranties. First, the subcontractor can attempt to secure an extended warranty from the manufacturer. If the extended warranty can be obtained, it is likely to involve an additional expense and the subcontractor will have to evaluate the expense against the risk of equipment failure. Second, the subcontractor could attempt to negotiate a modification to the subcontract providing that the warranty on key equipment in the system will commence once the equipment has been installed and tested on site, even if the entire system is not yet substantially complete. (This may be a tough sell with the general contractor, particularly if it is required to warrant the entire work for one year after substantial completion.) Third, the subcontractor can recommend that the key components of the system be placed under a service and maintenance agreement with the manufacturer, so that problem conditions can be identified and addressed by the manufacturer as part of normal maintenance and repairs under the service agreement.

The Other Warranties on Subcontractor Work

Beyond the warranty on equipment, the typical subcontract form requires the subcontractor to warrant all of its work against deficiencies and defects in materials and workmanship. It is required to correct such deficiencies or defects within the warranty period (usually one year) without cost to the owner or the contractor. The AGC/ASA/ASC Standard Form Construction Subcontract adopted in 1994 is more favorable to the subcontractor than prior agreements in "starting the clock" on the warranty period from "substantial completion of all or each designated portion of the Subcontract Work or acceptance or use by the Contractor or Owner of each designated area, system, equipment, and/or item, whichever is sooner" (emphasis added). The subcontractor must also take note of the potential for special warranties that may be identified in the project specifications and may run beyond the one-year period.

The owner or general contractor may also bring an action against the subcontractor after the warranty period has expired for breach of contract, asserting that the materials and equipment were not of good quality and new, were not free from defects, or did not conform to the requirements of the subcontract documents. That type of claim can be made at any time until the statute of limitations has expired on the contract (six years in many states).

Defenses to Warranty Claims

Each individual warranty or construction defect situation must be evaluated based upon its specific facts and the laws of the jurisdiction. However, there are some general principles that apply to the defense of warranty claims. First, if there is any indication that the equipment may have been defectively manufactured, the subcontractor should consider making a claim against the manufacturer, notwithstanding the expiration of the manufacturer’s warranty. In the case of Acme, the manufacturer was placed on notice of a problem with the compressor and had the opportunity to remedy the problem during the warranty period. Since the manufacturer did not resolve the problem and the equipment subsequently failed (even though the failure occurred after the warranty period), Acme would have a very valid claim against the manufacturer.

Second, the subcontractor’s warranty does not typically extend to damage or defects caused by abuse, modifications not performed by the subcontractor, improper or insufficient maintenance, improper operation, or normal wear and tear. Therefore, the subcontractor may have a defense if the general contractor or owner has tampered with the equipment after project close-out or if the maintenance and repair specifications were not carefully followed.

Third, the subcontractor may have a defense relating to the timing of expiration of its warranty, based upon the contractor’s or owner’s acceptance of the particular item of the work, even if the claim arises within one year of substantial completion of the subcontractor’s entire work. Like repair and maintenance questions, that issue will be primarily resolved based upon the facts of the particular situation.

Summary

Like payment terms, warranty provisions can easily become a battleground for owners, contractors, and subcontractors. The subcontractor cannot expect to eliminate the warranty as to its own work, but may be able to control the timing for the commencement of the warranty and its duration. The subcontractor does have some control over equipment warranties and may be able to "hedge" its risk by extending those warranties. If the subcontractor is called back for warranty work during the warranty period, it is particularly important that the subcontractor maintain careful records as to what work was requested, what work was performed, and that the owner or general contractor accepted the correction.

 

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