November/December 2005 Newsletters

 

Katz & Stone, L.L.P. Construction Newsletter
November/December 2005

COURT ALLOWS OWNER TO KEEP RETAINAGE FINDING PROJECT NOT SUBSTANTIALLY COMPLETE

Construction contracts generally allow the owner to retain a percentage of the cost of the contract until the project is substantially complete.  However, as RLI Insurance Company v. MLK Avenue Redevelopment Corp., 2005 Ala. LEXIS 97 (2005) demonstrates, courts will allow the owner to keep the retained amount permanently if the contractor refuses to complete the requisite work needed to bring the project up to appropriate standards per the contract.

In RLI Insurance, an owner purchased land from the city and planned to develop the land into residential subdivisions.  An engineer was hired to prepare plans and to provide instructions relative to the execution of the work.  Soon thereafter, the owner awarded the construction contract to the contractor, and the surety issued a performance bond on the job.

After construction began, it was determined that the site soil was unsuitable and needed to be replaced.  Pursuant to a change order, the contractor replaced the soil and was paid accordingly.  Prior to construction, the engineer wrote the city and requested a final inspection for the city to accept the project.  Instead of accepting the work, the city requested that additional work be performed.  The engineer objected, but the city still disagreed and presented a list of corrective measures.  Nonetheless, the contractor still performed some of the work, and it was eventually accepted by the city.

After acceptance, problems developed with the contractor’s work.  The city sent a letter to the owner describing additional work needed in order to meet appropriate standards.  Accordingly, the owner asked the contractor to finish this additional work, but the contractor refused.  Furthermore, the surety refused to have the work completed or pay the owner to have the work completed per the performance bond.  As a result, the owner did not pay the retainage to the contractor because the contractor did not substantially complete its work under the contract.

The owner sued the surety seeking specific performance under the bond.  The owner alleged that the city refused to take over maintenance of the work because of deficiencies in the contractor’s work.  As such, the owner asked the trial court to order the surety to hire a new contractor to complete the work.

The trial court found that the contractor was required to construct the subdivision per the plans and city standards.  Ruling in favor of the owner, the court concluded that deficiencies existed in the project and attributed these deficiencies to the contractor’s failure to construct the project in accordance with the contract.

On appeal, one of the surety’s arguments was that the trial court erred in failing to reduce the damages awarded to the owner by the amount of the unpaid retainage.  Specifically, the surety argued that because the contractor substantially performed pursuant to the main purpose of the contract, the surety could enforce the owner’s promise to pay the contractor.  Accordingly, the surety should be entitled to an offset for the amount retained by the owner, which was never paid to the contractor.  In response, the owner argued that the payment of the retainage to the contractor was conditioned upon final completion and acceptance of the work which never occurred.  The court found that there was credible evidence—the city had written a letter to the owner stating that a significant amount of work had not yet been completed—to support the finding that substantial performance had not occurred.  Thus, the surety’s claim for an offset with respect to the contractor’s unpaid contract retainage was denied.

As RLI Insurance demonstrates, courts are willing to allow an owner to withhold amounts retained if the project is not substantially complete.  Contractors and sureties should be aware that they may be forced to surrender claims for amounts retained per the contract if the contractor walks away from a project that is not substantially complete as to the main purpose of the contract.

NEW HAMPSHIRE COURT DENIES CONTRACTOR’S ENTITLEMENT TO LIEN FOR CERTAIN CHANGE ORDERS DUE TO INSUFFICIENT EVIDENCE

In many jurisdictions, simply performing work entitles a contractor to claim a mechanic’s lien.  However, as demonstrated in H.E. Contracting v. Franklin Pierce College, 360 F. Supp. 2d 289 (D.N.H. 2005), contractors must still present sufficient evidence of their right to recover for each item of work and dollar amount claimed in the lien.

Here, a contractor contracted with a college to perform work related to the construction of athletic fields and facilities.  During the project, the sitework contractor submitted nine change orders.  Although, the contractor ultimately withdrew Change Order 3 and the college approved Change Orders 4-6, the college rejected the other change orders (Change Orders 1, 2, 7, 8, 9,) because they covered work already included within the contractor’s contractual scope of work.  The contractor asserted that it had completed ninety percent of its work under the contract, and sought payment of the contract balance, which included amounts for Change Orders 1, 2, 7, 8, and 9. The college rejected the claim, and found that the contractor had only completed sixty percent of its work under the contract.  The contractor brought suit for breach of contract and quantum meruit against the college.  The contractor also sought a mechanic’s lien against the college for the contract balance, which included the amounts for Change Orders 1, 2, 7, 8, and 9.

Initially, the court concluded that the contractor had produced sufficient evidence to demonstrate its basic right to a lien for the contract balance.  However, the college took exception to the value of the contractor’s lien, especially with regard to the change order amounts.  Accordingly, the court examined the sufficiency of the contractor’s evidence regarding the change orders, and determined the proper value of the lien.

The court held that the contractor failed to adequately show that the work described in Change Orders 2 and 8 pertained to work outside of the contractual scope of work.  Specifically, the site plan incorporated by reference in the contract showed an area of clearing which encompassed the work that the contractor claimed required additional compensation.  In addition, the contractor admitted at the hearing that it never produced supporting documentation for Change Order 7.  The court also found that the contract expressly required that the contractor obtain written authorization from the college for extra or changed work, and that no claim for extra work was allowed unless the work was done pursuant to written authorization.  The contractor could not show that it received authorization for the work claimed in Change Orders 2, 7 and 8, or that the college had actual knowledge that the contractor was doing such work beyond the scope of the contract.  Accordingly, the court rejected the contractor’s claim for a lien for Change Orders 2, 7 and 8.

By contrast, the court found that the college had actual knowledge of the circumstances underlying Change Orders 1 and 9; thus, the college could be found to have dispensed with the written authorization requirement.  In response to Change Order 1 (which sought payment for delays due to late permitting of the sitework) the college claimed that there was other work that the contractor could have performed before the permits were granted.  However, the court found insufficient evidence of such other work, and held that the contractor had sufficiently demonstrated its right to recovery on Change Order 1.  Furthermore, with respect to Change Order 9 (which sought payment for project management costs) the college admitted that it had initially agreed to the contractor’s president serving as project manager.  As such, the court concluded that the college had actual knowledge of the contractor’s project management work, which was outside of the scope of the contract; the contractor had established its right to recovery on Change Order 9.

As H.E. Contracting shows, contractors seeking a lien must be prepared to prove that they are entitled to recover for each item of work and dollar amount claimed in the lien.  If the court is not satisfied with the contractor’s evidence regarding its right to recovery, the court may deny the contractor a lien for that item or amount.

QUANTUM MERUIT CLAIM CAN INCLUDE COSTS INCURRED BUT NOT YET PAID

A contractor may recover in an action for quantum meruit against an owner for amounts owed, but not yet paid, to subcontractors.  This proposition is illustrated in the case of Fluor Daniel Caribbean, Inc. v. Humphreys (Cayman) Ltd., 2005 U.S. Dist. LEXIS 9773 (S.D.N.Y. 2005).

In this case, a contractor entered into a construction contract with an owner.  As the project progressed, the contractor became concerned with the owner’s ability to pay amounts due under the contract.  As a result, the contractor made multiple demands upon the owner to provide reasonable evidence that sufficient financial arrangements had been made by the owner to fulfill its payment obligations to the contractor.  Despite the contractor’s repeated demands, the owner refused to respond or provide an adequate response to the contractor’s demands. Accordingly, the contractor brought an action against the owner for breach of contract and quantum meruit, citing the owner’s failure to fulfill its financial obligations under the contract as the basis for the suit. In its claim for quantum meruit, the contractor included amounts owed, but not yet paid, to its subcontractors. 

In response, the owner filed a motion for partial summary judgment seeking to limit the contractor’s quantum meruit recovery to those amounts actually paid by the contractor to its subcontractors.  The owner argued that the contractor could not recover in quantum meruit for amounts that were due, but not yet paid, to the subcontractors, as well as for project costs which the contractor had not yet paid.  The owner based its arguments on the fact that the contractor had yet to confer any benefit on the owner for the claimed amounts; it was not proper for the contractor to recover for amounts due, but not yet paid, to its subcontractors because the subcontractors could recover such amounts directly from the owner.

The court disagreed with the owner’s objection to the contractor’s claim under quantum meruit, and ruled in favor of the contractor.  The court noted that the owner failed to cite any relevant provision of the contract or any of the contractor’s subcontracts to support its position.  In addition, the owner failed to provide any other evidence that the owner was directly liable, or assumed any responsibility, for amounts owed by the contractor to its subcontractors.  In examining the contract, the court observed that the contract contained a provision which explicitly provided that there was no contractual relationship between the owner and any of the subcontractors.  In addition, the contract required that the contractor’s subcontracts include a provision which stated that the owner has the right—not the obligation—to assume the rights and obligations of the contractor under the subcontracts in the event of termination.  Finally, the court found that neither the contract nor the subcontracts held the owner liable to the subcontractors, or provided the subcontractors with any method to recover directly from the owner.  Thus, there was no danger that the owner would be subject to the risk of double payment.    

In support of its decision, the court noted that even if the contractor could not recover against the owner under quantum meruit for amounts due, but not yet paid, to its subcontractors, the contractor would still remain liable to its subcontractors.  This would lead to a windfall for the owner (the owner would receive the benefit of the subcontractors’ work without liability) and a detriment to the contractor (the contractor would be forced to absorb all liability for payment of its subcontractors).  Therefore, if the owner benefited from the subcontractors’ work and had not yet paid the contractor or the subcontractors for that work, then the owner could be held liable to the contractor for the value of such work.  Accordingly, the court ruled that the contractor, in its quantum meruit claim, could include those amounts owed, but not yet paid, to its subcontractors.

“MISSISSIPPI COURT REJECTS CLAIM THAT EXPRESS PROVISIONS OF COUNTY CONTRACT IMPLICITLY MODIFIED BY FEDERAL FUNDING

Construction disputes often arise due to conflicts between a contract’s express provisions and a project’s unique circumstances.  As the decision in Humphreys County, Mississippi v. Guy Jones, Jr. Construction Co., Inc., 910 So. 2d 1129 (Miss. Ct. App. 2005) demonstrates, without clear evidence that a contract has been formally modified to take account of possible unique circumstances, the contract’s express provisions will be interpreted as written.

The county retained the contractor to build a multipurpose building.  The contract provided that all progress payments were due within fifteen days after the contractor’s application for payment was received.  Some of the project funding came from a federal rural development agency, which conducted a pre-construction conference to discuss, among other things, the agency’s responsibility to accept or reject partial payment estimates and to monitor funding.  When the county failed to make progress payments within the timeframe established by the contract, the contractor brought suit under state law.  Although the contractor’s presence at the pre-construction conference placed the contractor on notice that partial payments had to be approved by the agency, the trial court found that the conference did not modify the contract; the timing of progress payments was governed by the contract’s provisions.  Moreover, the court found no evidence to support the county’s argument that federal regulations preempted state law and governed the contract and the timeliness of payments thereunder.  In accordance with state law, the trial court awarded the contractor interest, costs, and attorneys’ fees due to the county’s payment delays; the county appealed the award.

On appeal, the county argued that the trial court’s award was improper because the project funds came partially from a federal grant and, as a result, the project’s payment procedures and requirements were under the authority of the federal government.  However, the appellate court held that the county failed to show that the federal government was the sole source of the project funds, or even the source of the specific funds at issue.  As such, the contract and its provisions were governed by state law, which prescribed specific remedies for untimely payments on public projects.  Further, the court held under state law that any evidence which would alter or vary the terms of the written contract—such as evidence of the impact of the agency’s involvement on the timeliness of progress payments, and the contractor’s knowledge of that impact—was inadmissible as parol evidence.  Thus, the timeliness of the county’s payments was to be determined only by reference to the express provisions of the written contract.  Finally, the court noted that the county was aware of the possibility of late payments due to the agency’s involvement.  The county could have incorporated a provision into the contract which addressed the potential delays, but chose not to do so to its own detriment.

The holding in Humphreys County presents a cautionary tale to both owners and contractors not to assume that the other contracting party is both aware of the project’s unique circumstances, and consents to an implicit modification of the contract to account for the circumstances.  If such circumstances conflict with express contract provisions, the relevant provisions should be formally modified to remove the conflict.