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  • Wisconsin Lawyer
    June
    12
    2009

    Green Development Opportunities and Risks

    Michael R. Christopher

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    "Going green" is an increasingly popular building protocol, with more governmental units offering tax or capital incentives to more developers in more municipalities. Lawyers well-versed in the green building protocol can help clients articulate their motivation for going green, identify the opportunities and benefits, and suggest creative solutions to minimize the significant risks inherent in green development.

    Wisconsin LawyerWisconsin Lawyer
    Vol. 82, No. 6, June 2009

    Green or sustainable development is not just a fad. Statistics from the United States Green Building Council (USGBC) indicate that in 2004, 2 percent of building starts were “green,” equaling about $10.2 billion in construction costs. By 2010, it is estimated that between 5 and 10 percent of all building starts, or $30-60 billion, will incorporate green building techniques.1 “Going green” might once have been just a politically correct buzz phrase, but that is clearly not the case now.

    Benefits of Achieving Green/LEED™ Building Status

    The motivation to build green. When a client asks a lawyer, “Is it worth it for me to build green?,” it is essential to carefully analyze the client’s motivation to construct a green building.

    Three types of motivating factors – often referred to as “the Triple Bottom Line” – influence green development decisions. These factors can be broadly categorized as economic, social, and environmental. If the client determines that economic concerns are the driving force behind the decision to build green, a careful cost-benefit analysis must be undertaken that includes the construction costs and the operational expenses. Economic considerations also can include having a building that gives the owner a market advantage. Social considerations focus on the increased efficiency, comfort, and safety of the end user. The owner also may be motivated to build green based on community recognition. Environmental justifications to build green include reducing negative environmental effects and maximizing the efficient use of energy resources.

    Governmental incentives to build green. There are both economic and noneconomic incentives to build green. At the federal level, the General Services Administration (GSA) recently adopted a green-building-LEED-certification requirement for tenant leasing. I.R.C. § 179(b) provides commercial property owners with tax deductions for energy-efficient property placed in service before Jan. 1, 2009. The federal stimulus package contains economic incentives to build green. Some states provide tax credits for constructing or renovating buildings that satisfy certain green standards.2 Wisconsin’s ability to follow this approach is limited because of the state constitutional provision that requires uniformity of taxation.

    At the local level, many initiatives, particularly noneconomic ones, promote sustainable development. Ninety-two U.S. municipalities have formal green-building initiatives. The number of U.S. cities with green-building programs has increased by 418 percent since 2003. Municipalities have used creative approaches to encourage green building. Some examples include additional floor area ratio (FAR) for LEED buildings, expedited permitting processes for LEED buildings, density bonuses for developments that incorporate green measures, utility rebates, and special technical assistance programs to help owners navigate the approval process.

    Many Wisconsin municipalities have encouraged green development. For example, Madison includes green-building costs as eligible expenses in its tax incremental financing guidelines. Waukesha, in conjunction with the Metropolitan Builders Association of Greater Milwaukee, has established the Wisconsin Tread HomeTM, which incorporates technologies and features that will be prevalent in homes in the year 2020. This futuristic home uses structured insulated panels, a tempered passive solar orientation, solar electrical generation, solar hot water heating, Energy Star® appliances, computer operated mechanicals, and permeable pavement. The 260,000-square-foot Northland Pines High School in Eagle River contains a constant-volume heating and air conditioning system with energy recovery. It is the first LEED gold-certified public high school in the country.

    Identifying the Legal and Business Risks of Going Green

    Lawyers must identify the risks associated with green building projects and recommend creative options to avoid or manage those risks.

    Risks for the owner. It is a mistake to justify the construction of a green building solely on the basis that it is “the right thing to do” and to avoid a careful analysis of the risks that might arise during the preconstruction, construction, and postconstruction phases of the project.

    During the preconstruction phase, the major risks that the owner faces are over-promising, failing to articulate what is meant by a green building, and failing to identify who is responsible for achieving those goals. A green building can mean different things to different people. (See the accompanying sidebar, “Green Building Key Terms.”) It can be tempting to promise a green building, because many municipalities require that larger projects attain a particular LEED certification level for the project to be approved or receive tax incentives. The lawyer’s task of spelling out exactly what is expected in the project and who will be responsible for what, is doubly difficult when green building expectations are in play.

    For example, a lawsuit arose in 2007 out of a multimillion-dollar condominium project on Maryland’s Eastern Shore.3 The project was seeking LEED silver certification from the USGBC. The litigation began when the contractor filed a $54,000 mechanic’s lien against the project. The development company owner filed a counterclaim of $1.3 million for negligence, delay, breach of contract, and defective workmanship. Half the claim’s value was tied to lost tax credits under a state tax credit project, when the developer argued that the contractor failed to construct an environmentally sound building in accordance with the LEED rating system. Although this lawsuit was settled before many of the particulars could be litigated and fully understood, the case clearly indicates that the failure to secure LEED certification from the USGBC is a major area for potential litigation.

    Michael R. 
Christopher

    Michael R. Christopher, U.W. 1972, is a partner in DeWitt Ross & Stevens S.C., Madison, and devotes his practice to real estate development with a concentration in green development, government relations, and land use mediation. Contact him at com mrc dewittross dewittross mrc com or www.dewittross.com

    Because the building owner expects that a green stamp of approval will translate into reduced operating expenses, higher rents, tax breaks, and good public relations, contractors or design professionals may be exposed to liability if those expectations are not met. This is a particular concern for smaller projects. For example, depending on the level of LEED certification that is targeted and the type of project involved, the added cost of going through the LEED process could be from 5 to 15 percent more than the traditional construction budget. Economies of scale are a major financial factor for the owner to consider.

    Once the owner has carefully identified the green goals and analyzed the risks at the preconstruction stage, the various professionals involved in the construction phase of a green building must assess their particular risks.

    Risks for the contractor. Not meeting contractual obligations (such as certification documentation and schedule deadlines) through either a direct failure or a failure of subcontractors are risks that all contractors face. A green project increases these typical risks because more professionals and additional approvals are involved at various levels. Communication breakdowns, faulty application of new procedures and materials, and change orders from the original project plan are all potential process failures that the contractor must address.

    The contractor also must anticipate physical failures. For example, a structural failure might result from poor understanding of new building materials or inadequate field practices. In addition, decay, mold, mildew, or leakage might occur as a result of low-quality exterior envelope (exterior skin and framing, excluding window assemblies and nonstructural roofing material), inadequate bulk order control, or misapplied building science during the construction of a green building.

    Risks for the design professional. When alleged defects cause a project not to perform as promised or not to be certified, often the architect or the LEED-certified professional must defend against potential liability claims. The typical errors-and-omissions liability policy might not cover claims arising out of a failed performance claim based on certification documentation. Therefore, many design professionals are concerned that designing a green building increases their standard of care. In fact, the American Institute of Architects changed its code of ethics and standard contract in 2008, to commit “the Institute and its members to become experts in sustainability.” One lawsuit was filed against an architect by a LEED silver-building owner after a tenant demanded a rent rebate, claiming that the promised healthier air quality had not been delivered and the tenant had seen increased sick days, poor production, and employee complaints about eye strain and drafts.

    Managing Risks for a Green Building Project

    Risks on any development project are managed by contracts, including express warranties, insurance, and bonds, the purpose of which is to clearly delineate responsibility and provide clear remedies. It is important for lawyers to be familiar with the way that contracts, insurance, and bonds interact in the green construction process.

    Use of contracts. The earlier in a project that contractual terms are negotiated, the better, because the bargaining power of the parties is generally most comparable before any work is performed. The owner’s bargaining power is compromised the moment someone begins to provide services for the owner without a written agreement.  

    A coordinated set of contracts among the project team members to clearly identify the responsibilities of particular team members is essential. For example, although the subcontractor purchases materials or equipment, the owner nonetheless can make it a condition of its agreement with the general contractor that the owner have approval and negotiation rights over the express warranties. It is crucial to define the expectations of the subcontractor, subconsultants, and suppliers, and the ability of the owner to enforce, negotiate, or approve the agreements among those team members.

    Liability caps are common in architect contracts, which typically contain a provision that neither party can recover consequential damages from the other. For example, while a loss of energy savings could be considered a direct damage, the loss of marketability that results because a unit is not LEED certified would be considered a consequential damage.

    If LEED certification is part of the contract, all parties need to understand the LEED appeal process. For example, if the USGBC rejects the project as not being LEED compliant, then that decision is typically not easy to appeal. The USGBC’s appeal process applies national standards instead of focusing on local conditions and thus often is seen as a time-consuming and cumbersome process to go through for owners and contractors who are accustomed to local dispute resolution. Because green building involves new materials, methods, and laws, it is essential to include in a detailed series of contracts how disputes will be resolved.

    Express warranties. Express warranties are one tool for managing the risks associated with expected performance of materials and equipment in a green project. For example, if the design team chooses equipment that functions properly but is inappropriate for the size of the project, the resulting damage to the owner would generally be classified as a design defect, subject to the errors-and-omissions coverage of the architect. If the equipment is appropriate for the project and functions properly but is poorly installed, this generally would be considered a construction defect, subject to the contractor’s general-liability insurance. If the equipment is appropriate for the project and is installed properly, but malfunctions, the owner’s options should include looking to the equipment manufacturer’s express warranties. Counsel should ensure not only that the owner obtains the benefits of such warranties, but also that the owner understands and negotiates the terms.

    Insurance and bonds. To be truly protected from the risks allocated under a risk management plan, the owner or developer of a green project must make sure it has sufficient resources to cover the potential liabilities. Insurance and bonds are two distinct resources to cover liabilities. An insurance policy is a two-party contract between an insurer and an insured, in which the insurer agrees to pay the insured’s losses arising out of certain activities. A bond is a three-party contract, in which a surety agrees to guarantee one party’s obligations to another third party. Payment and performance bonds can be obtained on a project at a cost similar to that for an insurance premium. The surety providing a payment bond insures that the contractor and its subcontractors are being paid, so the project is not delayed. The surety providing a performance bond insures that if the contractor or a subcontractor ceases performance and fails to provide guaranteed future performance, other entities will be brought in to complete performance of the construction contracts. It is crucial to review the exclusions and endorsements issued with insurance and bonds, because they might exclude from coverage the precise matter for which coverage is sought.

    What is most important with these tools is understanding their limitations. For instance, insurance for construction defects created by a contractor or its subcontractors often is covered by the contractor’s commercial general liability insurance policy. Design defects, on the other hand, are only covered by the errors-and-omissions policies of the architect or its engineers. The default form of nearly all commercial general liability and errors-and-omissions policies, however, limits coverage for liability created by a breach of a contractual obligation or an express warranty. Instead, coverage is provided only for performance of services below the standard of care for the profession. Although other insurance programs that can bridge this gap in coverage may be available, it is important to have an insurance broker and attorney who understand the nuances associated with the various insurable and uninsurable risks of green development.

    There has been much discussion about how design team errors-and-omissions policies apply to green buildings. Some people argue that because an architect certifies, warrants, or expressly promises under the terms of its agreement to design a project that will perform as specified, if the project does not perform in this manner, the owner has an express contract or express warranty claim that is not subject to coverage under the architect’s policy. In this situation, language could be added to the owner-architect contract clarifying that contract terms pertaining to achieving performance standards are for a certification only and are not intended to effect a warranty or a guaranty.

    Conclusion

    Incorporating green development principles in real estate projects is now a given whether the project involves the renovation of an existing building or for new construction. The economic, social, and environmental benefits of building a green project are quite significant. Whether the intent is to reduce operating expenses, to construct a safer, healthier, and more efficient building for the end user, or to reduce negative environmental impacts in our world, the going green movement is here to stay.

    When considering building green, the owner must identify the motivation to build a green project and assess the risks. The owner must have an experienced team of professionals to provide advice on this question, including a lawyer who is well-versed in this area. Once the risks are identified, creative measures can then be taken to minimize those risks.

    Endnotes

    1McGraw-Hill Construction 2008; Key Trends in the U.S. and European Construction Marketplace, SmartMarket Report.

    2Maryland, which incorporates the LEED rating system, and New York, which does not strictly follow the LEED certification process, both provide tax credits if an owner decides to build or renovate green.

    3Southern Builders v. Shaw Co. LLC (Somerset County, Maryland) (2007).