Even the most reputable and quality conscious contractors, subcontractors and suppliers engaged in the road and bridge industry are occasionally faced with the prospects of removing and replacing defective work and materials. Indeed, human error can evade even the most well-planned and executed quality-control measures. The typical construction contract contains provisions which demand strict compliance with the plans and specifications, and even the owner’s implicit or interim approval of the work through the inspection process will generally not excuse the contractor from the burden of making good defective or non-conforming work. But what if the non-compliance or non-conformity does not impair the effective use of the work as intended, and the cost of removing and/or repairing the work is substantial? The economic waste doctrine, which has been adopted in most states as well as in federal government contracting, is intended to inject a little common sense into these situations and, while providing relief to the contractor, insure that the owner still gets the benefit of its contractual bargain.
The economic waste doctrine prevents an owner from demanding repair or replacement of nonconforming work if (1) the work is otherwise substantially performed and is fit for the purpose intended; and (2) the cost of repairing and/or replacing the work is disproportionately higher than the diminution in the work’s value as a result of the nonconformity. Both requirements must be met in order for the contractor to avoid repairing or replacing the work.
As to the first requirement, the non-conformity must not render the project or particular feature of the project unusable. In Granite Construction Co. v. U.S., 962 F.2d 998 (Fed. Cir. 1992), a contractor constructing a concrete dam for the U.S. Army Corps of Engineers, embedded waterstop into concrete that was later determined to be out of compliance with the project specifications. The contractor offered several remedial options in response to the Corps’ initial demand that all nonconforming materials be removed and replaced. However, the Corps rejected all of the contractor’s proposals and insisted on removal and replacement.
At trial, the contractor admitted that the waterstop, in fact, did not comply with the specifications, but presented expert engineering testimony showing that the material would nevertheless function and perform within the appropriate design safety factors for the project. The expert also testified that at least one of the several remedial proposals the contractor offered would have sufficed. The Corps of Engineers Board of Contract Appeals, a predecessor tribunal to the current Armed Services Board of Contract Appeals, rejected the contractor’s argument and ruled for the Corps. But, the U.S. Court of Appeals for the Federal Circuit reversed the board’s decision and held that the contractor had adequately met its burden of proving that the waterstop—albeit nonconforming—was in substantial compliance and would achieve the intended purpose of cutting off the flow of water. It, therefore, awarded the contractor the difference between the contractor’s actual removal and replacement costs and the estimated cost of performing the repair that was deemed adequate.
The second requirement for application of the economic waste doctrine—a significant disparity between the cost of repair/replacement and the diminution in value of the defective work—is typically the issue that prompts a contractor to question the propriety of repair/replacement of the nonconforming work in the first place. Unfortunately, no hardline percentages or rules exist concerning the extent of the disparity that must exist between the cost of repair/replacement and the diminution in value, and courts vary greatly in their decisions in this regard. Generally, however, as the materiality of the nonconformity increases, courts are more likely to order repair/replacement despite substantial disparities between the cost of repair/replacement and the diminution in value.
The economic waste doctrine is not a mechanism for contractors to avoid their contractual obligations. Rather, it is available in those rare instances where removing and replacing nonconforming work makes no sense from a cost/benefit (i.e., common sense) standpoint. When properly applied, the contractor avoids substantial repair or replacement costs that would yield an insignificant benefit, and the owner is adequately compensated via a credit for any decrease in value or life expectancy of the work. For this reason, contractors and owners should investigate the factual scenarios under which courts in their states have applied the economic waste doctrine.