November/December 2002 Newsletters

 

Katz & Stone, L.L.P. Construction Newsletter
November/ December 2002

 

ACCORD AND SATISFACTION: ACCEPTING REDUCED “FINAL PAYMENT” MAY PROHIBIT SUBCONTRACTOR FROM RECOVERING ADDITIONAL AMOUNTS

The legal doctrine of accord and satisfaction is triggered when two parties agree to accept a stipulated performance in settlement of a dispute. The agreement is known as the “accord” and the performance of the agreed-upon terms is known as the “satisfaction.” In the construction context, accord and satisfaction often arises when a contractor tenders a final payment to a subcontractor for less than the subcontractor claims is owed. In such a situation, if the contractor clearly and conspicuously declares that the reduced payment constitutes “final payment,” the subcontractor has only two options: the subcontractor may accept the reduced payment in final satisfaction of the disputed debt, or the subcontractor may refuse the reduced payment and thereby reserve its right to pursue the entire debt.

In the case of Gelles & Sons General Contracting, Inc. v. Jeffrey Stack, Inc., 264 Va. 285 (2002), a contractor and subcontractor disputed the amount owed the subcontractor for final payment. When the subcontractor cashed the contractor’s “final payment” for less than the amount it claimed to be owed, the subcontractor was barred from seeking any additional amounts.

In Gelles, the contractor subcontracted out brick work. A dispute arose when the masonry subcontractor submitted a final invoice requesting $26,175 and the contractor asserted that the contract balance was only $13,580. After the subcontractor demanded full payment of its invoice, the contractor sent a letter detailing deficiencies in the subcontractor’s work and concluding that it would “stand by its final amounts as stated in the latest correspondence... Enclosed please find a check in the amount of $13,580 representing final payment on the contract.”

The subcontractor cashed the check and subsequently filed a lawsuit seeking the remaining balance. The contractor argued that the subcontractor’s action was barred by an accord and satisfaction, namely the cashing of the check in light of the “representing final payment on the contract” language in the letter. To establish an accord and satisfaction, the contractor in this case had to prove that (1) it tendered the amount in good faith and in complete satisfaction of the claim; (2) the amount of the claim was subject to a legitimate dispute; and (3) the subcontractor obtained payment (i.e. cashed the check). Because the contractor adequately established these facts, the subcontractor was barred from seeking additional amounts.

On appeal to the Supreme Court of Virginia, the subcontractor argued that the language in the contractor’s letter, quoted above, failed to clearly inform the subcontractor that the check was being offered in full satisfaction of the claim. Applying what is referred to as the “reasonable person” standard, the court rejected the subcontractor’s argument holding that a reasonable person would have understood that the check was offered in full satisfaction of all amounts owed to the subcontractor.

To establish an accord and satisfaction, there must exist a genuine, good faith dispute as to the amount due. Provided such a dispute exists, a statement that the payment tendered constitutes final payment serves to extinguish any claims for additional compensation. This statement may appear in correspondence accompanying the payment or, if payment is made by check, on the face of the check.

For those who consider the doctrine of accord and satisfaction to be harsh, it should be noted that most states, including Virginia, allow a party that cashes a “final payment” the opportunity to repay the payor within 90 days, and thereby to nullify any accord and satisfaction otherwise created by the cashing of the payment. Thus, if a subcontractor accepts a reduced final payment, it may return the payment to the payor within 90 days of receipt, thereby allowing the subcontractor to seek its entire outstanding balance. Note, however, that cashing the check with a reservation of rights, or after striking out the “final payment” language on the check, will not suffice. The subcontractor must accept or reject the tendered payment as it is tendered; the subcontractor may not modify the terms under which the payment is offered and seek the remaining amount claimed to be due. The subcontractor may either accept the check in full payment, and waive the remainder of the balance, or not accept the check at all.

The Gelles case highlights the hazards of accepting payments tendered as final payment of a disputed debt. Personnel responsible for receiving and processing payments should review every payment and any accompanying correspondence for language asserting that the amount tendered serves as a final payment. Failure to do so may bar recovery of any additional claimed amounts. Consequently, contractors are well-advised to ensure that payments received do not claim to be final payments and to understand the consequences of accepting payment under such conditions.

 

NINTH CIRCUIT RULES THAT SURETY CANNOT RELY ON “PAY IF PAID” CLAUSE BETWEEN PRIME CONTRACTOR AND SUBCONTRACTOR AS DEFENSE TO MILLER ACT BOND CLAIM

Subcontractors familiar with the effect of “pay if paid” clauses realize that, if they agree to such a clause in a subcontract, they have no contractual right to payment from the general contractor unless the general contractor has itself been paid. Many subcontractors do not realize, however, that in some jurisdictions a pay if paid clause might also affect their right to recover under a payment bond. In Walton Technology, Inc. v. Weststar Engineering, Inc., 290 F.3d 1199 (9th Cir. 2002), a federal court’s divided opinion recently illustrated the growing debate over the effect of such clauses on payment bond rights.

In Walton Technology, a subcontractor working on a project for the Navy sued the general contractor and the general contractor’s Miller Act surety to recover delinquent rental payments for equipment the general contractor had rented. Although the rental period was originally scheduled to end in September 1996, various delays prevented the general contractor from completing the project on schedule. By late October 1996, the general contractor was delinquent on rental fees and other payments in the amount of $108,000.

On November 1, 1996, the subcontractor filed suit in federal district court against the payment bond furnished by the general contractor pursuant to the Miller Act. The court dismissed the subcontractor’s claim, finding that it was premature because the general contractor had not been paid by the Navy. The court held that, because the parties had agreed to a pay if paid clause, the general contractor would only be obligated to pay the subcontractor “if and when” it was paid by the government. Because such payment had not occurred, the court concluded that there were no "sums justly due" under the Miller Act and, therefore, the subcontractor had no bond claim.

On appeal, the Court of Appeals for the Ninth Circuit, whose decisions govern federal law in Montana, Idaho, Washington, Oregon, California, Nevada, Arizona, Alaska, Hawaii, Guam, and the Northern Mariana Islands, reversed. The appellate court explained that the Miller Act is "highly remedial” and is to be liberally construed to further Congress’ intent in passing the Act “to protect those whose labor and materials go into public projects." As such, the court refused to define the extent of a surety’s liability under the Miller Act solely by the extent of the principal’s (i.e., the general contractor’s) contractual liability to its subcontractor. The court noted that the Miller Act expressly establishes a subcontractor's right to bring a bond claim once 90 days have passed after completion of its work. As there was no dispute in Walton Technology that the subcontractor had not been paid within 90 days of completing its contractual obligations, the court refused to allow the surety to use the subcontract’s unsatisfied pay if paid clause as a defense to the subcontractor’s bond claim. The appellate court concluded that permitting a Miller Act surety and principal to avoid liability because of a pay if paid provision would frustrate the purpose of a Miller Act payment bond and preclude a subcontractor from bringing a Miller Act claim without a clear and explicit waiver of its right to do so.

The decision, however, was not unanimous. In dissent, one judge wrote that the majority’s opinion advanced “the peculiar proposition that a Miller Act surety is liable to a subcontractor on a Miller Act payment bond even though the bonded principal owes nothing to that subcontractor.” The dissent opinion stressed a long-standing rule of the surety/principal relationship that a surety stands in the shoes of its principal and may avail itself of any defense available to the principal. According to the dissent, the “very essence of suretyship” is the concept that, if the principal is not liable to a subcontractor, the surety is not either. As such, in the dissent’s opinion, the majority opinion erred in ruling that the surety did not have a defense on the basis of the pay if paid clause.

Walton Technology illustrates the importance of knowing whether a subcontract’s unsatisfied pay if paid clause will stand in the way of enforcing payment bond rights under applicable law. While the outcome in Walton Technology represents a victory for subcontractors working on federal projects, the decision is binding only in those states that are subject to the Ninth Circuit’s jurisdiction. Federal project subcontractors working outside the Ninth Circuit, and subcontractors bringing claims against a private or state payment bond, should look to controlling courts in their jurisdiction for guidance as to whether they would agree with the majority or dissent in Walton Technology.

 

GENERAL CONTRACTOR DID NOT RETAIN SUFFICIENT CONTROL OVER SUBCONTRACTOR’S WORK TO TRIGGER LIABILITY FOR INJURY TO SUBCONTRACTOR’S EMPLOYEE

As a general legal principle, a contractor is not liable for an injury to an employee of an independent contractor caused by the independent contractor’s negligence. While general contractors often cite this principle to avoid liability for an injury to a subcontractor’s employee caused by the subcontractor, courts have recognized exceptions to the rule when the general contractor has control of the job site or has retained control of the manner in which the subcontractor performs its work. In Bieruta v. Klein Creek Corp., 770 N.E.2d 1175 (Ill. App. 2002), one court recently considered whether a general contractor should be held liable for an injury to a subcontractor’s employee based on its alleged control over the subcontractor’s work.

In Bieruta, an excavation subcontractor’s employee was injured on a job site when he fell into an open trench. The employee brought suit against the project’s general contractor, claiming that the general contractor retained sufficient control over safety on the job site to give rise to a duty to provide a safe working place. The general contractor argued that it bore no such duty to the employee and the trial court agreed, dismissing the employee’s suit. The employee then appealed.

Affirming the lower court, the appellate court held that a general contractor is not liable for a subcontractor’s negligence unless the general contractor retained control of any part of the subcontractor’s work. If control is retained, the general contractor owes a duty to exercise reasonable care to the subcontractor’s employees and will be liable for physical injury caused by its failure to fulfill that duty. Examining the type of control necessary to trigger liability, the court stated that it is not sufficient for the general contractor to merely have a general right to order work stopped or resumed, inspect its progress, or make non-binding recommendations. Rather, the contractor must exercise a right to control the methods and operative details of the subcontractor’s work such that the subcontractor is not entirely free to do the work his own way.

Here, the court found no indication that the general contractor exerted any control over the mass excavation of townhouse lots performed by the subcontractor. The general contractor did nothing more than tell the subcontractor where to excavate and did not direct the operative details of the work performed by the subcontractor or its injured employee. The subcontractor, not the general contractor, was responsible for the methods, means and techniques used in performing its work, supplied all of the equipment used by the employee, and instructed the employee on matters of safety in and around the excavation. Furthermore, the court concluded that, even if the method of excavating chosen by the subcontractor was dangerous and led to the employee’s injury, there was nothing to suggest that the general contractor knew or had notice of the hazardous method being employed.

Though the extent to which a general contractor controls a subcontractor’s work may be determined by the provisions of the prime contract or by the needs and exigencies of a particular project, general contractors should consider adding language to their subcontracts, when appropriate, that clearly places responsibility for controlling the means and methods of performing the work on the subcontractor. In the event that a subcontractor’s employee is injured due to the subcontractor’s own negligence in performing the work, such language will help the general contractor avoid legal responsibility. If control over the means and methods of the subcontractor’s work cannot be delegated by contract, general contractors should, at a minimum, require their subcontractors to take reasonable safety precautions in performing their work, and to comply with all safety measures initiated by the general contractor or required by law.

 


COURT HOLDS GENERAL CONTRACTOR TO UNAMBIGUOUS
TERMS OF ITS SUBCONTRACT; REFUSES TO ALLOW CONTRARY, UNDOCUMENTED COMMUNICATIONS TO MODIFY TERMS

It is not uncommon for a contractor to encounter a situation in which his written contract expressly requires him to do one thing, but the contractor, due to his negotiations with the other party to the contract, comes to believe he is obligated to do something else. As the decision in Tshiggfrie Excavating Co. v. Midwest Rail & Dismantling, Inc., 2002 Iowa App. lexis 559 (May 31, 2002), demonstrates, however, when a written contract’s terms are explicit, courts are reluctant to enforce contrary understandings or intentions on the basis of prior, undocumented communications.

In Tshiggfrie, a general contractor working on a construction project at a John Deere plant subcontracted out a portion of its concrete crushing work. The subcontract called for the subcontractor to crush approximately 8,000 tons of concrete for the sum of $36,000. When the subcontractor determined that it had crushed 8,000 tons of concrete, it notified the general contractor that its work was complete. As at least 4,000 tons of concrete remained to be crushed on the project, the subcontractor also offered to crush the excess concrete for an additional $18,000. The general contractor rejected the offer and hired another subcontractor to crush the remaining concrete.

Asserting that it had fully complied with its contractual obligation to crush approximately 8,000 tons, the subcontractor demanded immediate payment. The general contractor refused, claiming that the parties intended the contract to be a lump sum or “whole job” agreement to crush all concrete on the project, and that the subcontract’s reference to approximately 8,000 tons of concrete was understood by the parties at the time of contracting to be a rough estimate of the entire job, not a limitation of the subcontractor’s work to a particular tonnage. The contractor based its interpretation of the written subcontract, which it had signed without modification, on discussions regarding the work which occurred prior to the subcontract’s execution. Ultimately, the subcontractor sued the general contractor for breach of contract, and the general contractor counterclaimed for the cost of hiring another subcontractor. The trial court entered judgment in favor of the subcontractor.

Upon appeal by the general contractor, the appellate court upheld the trial court’s decision. The court found that, when construing a written contract, courts are guided by the rule that the intent of the parties controls and, except in cases of an ambiguous term, intent is determined by what the contract itself says.

In light of the explicit and clear language of the subcontract calling for “approximately 8,000 tons” of crushed concrete at a fixed price, the appellate court agreed that the subcontract was not ambiguous, the parties’ intent was clear from the subcontract’s terms, and the trial court was correct to enforce the subcontract as written. Accordingly, the appellate court affirmed that the subcontractor fully performed its obligation under the unambiguous terms of the subcontract by crushing approximately 8,000 tons of concrete, and was thus entitled to be paid $36,000.

Tshiggfrie makes clear to contractors that, when presented with a written contract containing unambiguous terms requiring something different than what was previously discussed or understood by the parties, the language must be changed or those terms will trump the prior discussions. When parties go to the trouble of documenting their agreement with a written contract, courts are likely to enforce what the parties have expressed in writing, not what they intended or understood but failed to express.