Hidden legal risks of green building.

• Author: Anderson, Maura K.
• Position: Real Property, Probate and Trust Law

Broadly referred to as "green" construction, the field of environmentally focused design and construction, which once seemed like a fad, has become mainstream. Many federal, state, and local initiatives either mandate or incentivize green building, and the green building market continues to grow, despite declining commercial and residential construction. Just as construction claims and disputes often accompany conventional construction projects, it is only a matter of time before green construction claims and disputes accompany green construction projects. (1) Green building litigation--or LEEDigation, as some commentators have coined it--could likely become prevalent in the near future because of the unique and unknown risks that accompany building green and the rising number of inexperienced entrants into the field. (2)

This article focuses on the hidden legal risks that owners, designers, and contractors should consider before undertaking a green project. This article also presumes that the reader possesses a modicum of familiarity with green building certification and the U.S. Green Building Council's (USGBC) Leadership in Energy and Environmental Design (LEED) rating system, which is currently the most popular green building rating system.

Hidden Legal Risks of Green Building

Green construction projects are different from conventional construction projects. Green building embodies a greater latent potential for unrealized expectations, misunderstandings, physical or economic failure, and litigation. Some of these risks are discussed in this article.

Owner Risks and Unfulfilled Expectations

When undertaking a green project, an owner likely expects to achieve green building certification. Failure to achieve the certification goal is an obvious risk, and the economic impact could be substantial. Potential damages to the owner can include, but are not limited to, the loss of a tenant or sale, loss of government incentives and tax credits, increased design and construction costs, rescinded donations on endowed projects, penalties on public projects with green mandates, increased energy and water costs over the life of the building, and diminished asset value.

Consequential damages arising from a breach of contract are an additional risk that may accompany a failure to achieve the certification goal. Hadley v. Baxendale, 9 Exch. 341 (1854), a leading and longstanding English contract law case, set forth the basic rule for determining the scope of consequential damages: A party is liable for all losses within reasonable contemplation of the contracting parties at the time of the contract. But green building is novel. Nobody knows the extent to which consequential damages might be awarded because case law has yet to define the losses that would likely be within reasonable contemplation of the parties to a green project. Confusion arises when green-related regulatory activity at the federal, state, and local levels is moving at a rapid pace, making it difficult to interpret regulations with certainty; insurance coverage for claims arising out of green design is largely unsettled; and insufficient data exists to determine whether green buildings are performing at the desired higher level of anticipated efficiency. (3)

Although a mutual waiver of consequential damages clause is commonly included within design and construction contracts, an owner could be placing himself or herself at an unacceptable level of risk by agreeing to this term. (4) An owner, therefore, should expressly define as liquidated damages any recoverable damages under the contract in the presence of a mutual waiver of consequential damages on a green project.

The first known LEED-related lawsuit involved lost tax credits. (5) In Southern Builders v. Shaw Development, No.: 19-C-07-011405, Circuit Court, Somerset Co., Md. (2008), the general contractor agreed to build a $7.5 million, 23-unit condominium project that was designed to obtain LEED Silver certification. The owner applied and qualified for a state income tax credit equal to 8 percent of the project cost. When the contractor failed to deliver a LEED Silver building and a certificate of occupancy within the time required under Maryland's green building tax credit program, the owner forfeited more than $600,000 in tax credits. (6) The owner alleged claims of negligence and breach of contract against the builder. While the case appears to have settled without a trial, it illuminates two key components of green building litigation: The parties failed to recognize the risks implicated by the applicable regulatory scheme, and the parties agreed to an imprecise contract. (7)

A prudent owner understands that the contract is the primary means for dictating a contractor's green building obligations. The parties in Shaw Development entered an AIA A101-1997 "Standard Form of Agreement between Owner and Contractor" as their general contract. This agreement does not include green building requirements. A separate project manual incorporated additional requirements and made specific reference to green building certification: The project is "designed to comply with a Silver Certification Level" according to the LEED rating system. (8)

The contract documents simply lacked clarity. While the project manual stated that the project was designed to comply with LEED Silver certification, it did not expressly obligate the contractor to secure formal certification from the USGBC. Instead, the contractor was only responsible for building according to the drawings and specifications. Thus, the contractor could be liable if it failed to build in accordance with the design, which, thereafter, resulted in a failure to achieve LEED certification. (9) In sum, an owner should clearly describe a contractor's responsibilities as they relate to the construction of a green building project. (10)

The contract documents should expressly assign LEED certification responsibilities to the appropriate party or parties. At a minimum, specific contractual terms should address responsibility for registering the project, compiling and maintaining documentation to obtain LEED credits, applying for certification, responding to USGBC requests for additional information or clarification, and prosecuting the appeal process in the event that the initial request for certification is denied. (11) Likewise, a cautious owner may consider adjusting retainage terms to coincide with the issuance of LEED certification. Ensuring the continued involvement of the architect and contractor may prove critical, because entitlement to certain LEED points can only be established after construction completion and commencement of facility operations. (12)

With the possibility of such large economic damages for unfulfilled expectations as discussed above, building owners can be expected to demand guaranteed LEED certification. That request can conflict with the design professional's and contractor's needs to manage their own risks; after all, owner changes, contractor actions, design decisions, and post-occupancy usage all affect various LEED credits and are not within the sole control of a single party. Although the interests of the owner, designer, and contractor are often harmonious, understanding the risks faced by all project participants is critical to success on a green project.

Architect Risks

Many architects, who would otherwise adhere to standard operating procedures and build risk management processes into their designs and contracts, may forget those basics when they begin to passionately discuss green design. (13) A successful green architect will set reasonable contract requirements, manage the client's...