September/October 2005 Newsletters

Katz & Stone, L.L.P. Construction Newsletter
September/October 2005

MARYLAND COURT HOLDS THAT SURETIES’ FAILURE TO TIMELY RESPOND TO BOND CLAIM WAIVES ALL DEFENSES TO THE CLAIM

Under most bonds, the sureties that issue them are only obligated to investigate and pay claims against the bond in a “good faith” manner.  However, if their bonds contain a deadline for responding to claims, as did the bond in Nat’l Union Fire Insurance Co. of Pittsburgh, Pa. v. David A. Bramble, Inc., 879 A.2d 101 (Md. 2005), sureties may have to process claims more expeditiously or risk waiving their defenses against the claims.

In Nat’l Union Fire, the subcontractor notified the sureties on the general contractor’s payment bond that it had not been paid in full by the general contractor.  The bond, an AIA Document A312 form, provided that, when the sureties received notice of a claim on the bond, they were required to (a) send an answer to the claimant, within 45 days after receipt of the claim, stating the amounts of the claim that were undisputed and the sureties’ basis for challenging any amounts that were disputed, and (b) pay or arrange for the payment of any undisputed amounts to the claimant.  However, the sureties failed to provide the subcontractor with such an answer, much less pay or arrange for payment to the subcontractor.  Rather, the sureties responded to the subcontractor’s claim notice only by expressly reserving their rights and requesting the subcontractor’s completion of a proof of claim form.  The subcontractor submitted the completed proof of claim form and supporting documentation to the sureties.  Nonetheless, the sureties again failed to provide the answer required by the bond and failed to pay or arrange for payment to the subcontractor.  Accordingly, the subcontractor filed suit against the sureties and moved for summary judgment on the grounds that the sureties had waived the right to challenge the subcontractor’s claim under the bond because they had failed to provide the answer required by the bond within 45 days. 

The trial court granted summary judgment in favor of the subcontractor, and the Maryland Court of Special Appeals affirmed the lower court’s ruling.  In turn, the Maryland Court of Appeals also upheld the lower court’s ruling.  The court found that the sureties did not deny that they ignored the requirements of the bond, but contended that, when they failed to answer within the 45-day period, the entirety of the subcontractor’s claim was disputed.  However, the court concluded that the language of the bond necessarily obligated the sureties to communicate with the subcontractor concerning what portions of the claim were subject to dispute.  Although the sureties had corresponded with the subcontractor within the 45-day period, they had not attempted to comply with the language of the bond.  Moreover, the court rejected the sureties’ argument that, because they failed to inform the subcontractor what amounts of the claim were undisputed and what amounts were disputed, the entire claim was in dispute.  The bond did not simply obligate the sureties to state which portions of the claim were disputed and undisputed; rather, it required that they specifically explain the grounds underlying their dispute.  Therefore, the court determined, it would be inconsistent with the plain meaning of the bond to interpret it to permit the sureties to dispute a claim through silence.

According to the court, the sureties’ interpretation of the bond would render the 45-day time requirement meaningless, violating the long-standing rule of contractual interpretation that a contract is to be interpreted so as to give effect to all of its provisions.  Moreover, to decide that the sureties could dispute the entirety of a claim by inaction would greatly undermine the bond's purpose of safeguarding the subcontractors and suppliers that it is supposed to benefit.  Because the sureties were compensated for providing the bond, and courts tend to construe contracts involving compensated sureties in favor of the party who benefits under the bond, the court held that construing the language of the bond in a manner favorable to the subcontractor, whose interests are protected by the bond, was proper under Maryland law.  Furthermore, the court rejected the sureties’ contention that such an interpretation would result in a potential expansion of the coverage of the bond, in that the sureties would be forced to pay for claims that, because of the pay-if-paid language in the subcontract, were beyond the scope of the bond’s coverage.  The sureties had failed to assert that any portion of the subcontractor’s claims was beyond the scope of the bond’s coverage within the 45-day period, and thus, under the plain language of the bond, the sureties were precluded from later arguing otherwise.

With the decision in Nat’l Union Fire, sureties whose bonds contain a deadline for responding to a claim must be careful to comply with such deadline or risk waiving all of their defenses to the claim.  Moreover, a claimant on such a bond should closely monitor the surety’s compliance with such deadline, as any failure by the surety to respond within the time and in the manner established by the bond could remove all obstacles to the claimant’s recovery under the bond.

 

RISK OF UNFORESEEN SUBSOIL CONDITIONS FALLS ON CONTRACTOR

The risk of unforeseen subsoil conditions can fall on a contractor if the contract disclaims the adequacy of the plans and specifications and unambiguously places the risk of unforeseen subsoil conditions on the contractor.  This lesson is illustrated in the case of Interstate Contr. Corp. v. City of Dallas, 407 F.3d 708 (5th Cir. 2005).

In Interstate Contr. Corp., a city entered into a contract with a contractor to construct a levee around a water treatment plant and excavate two detention lakes.  The contractor contracted with a subcontractor to perform work related to the levee construction and excavation.  The contract required the contractor to use the material excavated on-site as fill material for the levee, to the extent the excavated material met specifications.  The excavated material did not meet specifications for construction of the levee, forcing the subcontractor to manufacture suitable fill by mixing sand with the excavated material.  This process substantially decreased productivity and increased project costs.  The contractor informed the city of the decreased productivity and resulting increase in costs, but the city denied the contractor’s claim.  In response to the denied claim, the contractor filed a breach of contract suit against the city on behalf of the subcontractor.

The contractor argued that the plans and specifications provided by the city were defective because they represented that that the contractor would be able to obtain suitable material to build the levee from the on-site excavation.  The contractor claimed that the city breached the contract by failing to cover the additional costs resulting from the need to manufacture suitable fill material to construct the levee.  In addition, the contractor alleged that the city did not provide the soil reports for inspection, despite the contractor’s demands.

The city argued that the contract placed the risk of unforeseen subsoil conditions on the contractor.  The city also contended that the contract did not require it to disclose information regarding the subsoil conditions.  The city relied on the contract, which contained several provisions disclaiming the adequacy of the plans and specifications and explicitly placing the risk of unforeseen subsoil conditions on the contractor. 

The court ruled in favor of the city.  The court found that the contract expressly and unambiguously placed the risk of inadequate plans on the contractor, regardless of whether the plans and specifications were incorporated into the contract.  The court ruled that the city did not breach the contract by providing the contractor with defective plans because the contractor had contractually assumed the risk of unforeseen subsoil conditions and inadequate plans. 

While such a result may seem harsh to the contractor because the project owner often possesses superior knowledge regarding subsoil conditions, the courts are likely to enforce contractual provisions which explicitly place the risk of adverse soil conditions on the contractor.  As a result, contractors should be wary of contractual clauses which attempt to allocate all of the risk of unforeseen subsoil conditions to the contractor.

 

SUBCONTRACTOR  MAY RECOVER FAIR COMPENSATION FROM THE OWNER FOR WORK PERFORMED OUTSIDE THE SCOPE OF CONTRACT WHERE THE OWNER REQUESTED THE WORK

In Northern Clearing, Inc. v. Larson-Juhl, Inc., 688 N.W.2d 784 (Wis. Ct. App. 2004), the Wisconsin Court of Appeals held that a subcontractor who performed non-gratuitous services outside of the scope of the original contract/subcontract was entitled to fair compensation for the extra work, where the owner requested the subcontractor to perform this extra work.

In Northern Clearing, an owner contracted with a general contractor to build a manufacturing facility on a seventeen-acre site.  The general contractor contracted with a subcontractor to excavate, clear, and grade the site.  Prior to excavation, the owner retained independently a surveyor to survey the site and place grading stakes throughout the property. 

After the survey was completed, the subcontractor began excavating the site.  However, after construction commenced, the subcontractor contacted the general contractor and the owner with concerns regarding the grading stakes.  Eventually, the general contractor and owner agreed to stop the excavation and grading until the grading discrepancy issues were resolved.  The parties determined that the surveyor erroneously placed the grading stakes.  As a result of the surveyor’s errors, the subcontractor excavated much more material and fill than specified under the building plans; approximately seventy percent of the seventeen-acre site needed to be re-filled. 

Shortly thereafter, the subcontractor agreed orally with both the contractor and the owner to remedy this problem.  Accordingly, the subcontractor was required to do much more work than was originally required under the contract.  However, no change order was ever obtained from the owner to compensate the subcontractor for its extra work, and the general contractor never gave any assurances that the owner would compensate the subcontractor for the extra work performed to correct the aforementioned survey errors.

After the owner denied payment to the subcontractor for its extra work, the subcontractor sued the owner on a theory of quantum meruit (the reasonable value for its services rendered), and based its claim upon an implied contract with the owner.  In response, the owner claimed that there was no proof that it requested these extra services from the subcontractor.  Further, the owner contended that the subcontractor only contracted with the general contractor to perform the extra work, and therefore the owner cannot be liable to the subcontractor.  After a trial was held, a judgment was entered in favor of the subcontractor.

The owner appealed to the Wisconsin Court of Appeals.  Again the owner argued that an award of damages was unfounded.  Specifically, the owner argued that the subcontractor contracted exclusively with the general contractor for the additional services, and performed the additional services without the request of the owner.

The Court of Appeals rejected the owner’s argument.  The Court of Appeals held that although there was no express agreement between the owner and the subcontractor, there was an implied contract between the two parties.  Reciting the applicable law, the Court of Appeals stated that if the circumstances and actions of the parties show that the parties had a mutual intention to contract, then an implied contract may exist.  Further, the parties do not need a written  agreement which memorializes the details of the agreement.  All that is needed is an implied promise that the performer will be paid upon completion of its services.  In order to recover under the theory of quantum meruit, there must be an implied contract between the parties which shows that the actions were performed at the request of one of the parties, and that the performer expected reasonable compensation for its actions. 

Applying these principles to the facts of the case, the Court of Appeals reiterated why an implied contract arose between the owner and the subcontractor.  Specifically, the facts showed that the subcontractor spoke with the general contractor and the owner regarding the problems with the survey and the grades, and that all parties agreed that the subcontractor should remedy the errors caused by the faulty survey.  Moreover, the facts revealed that the owner accepted the subcontractor’s extra services without objection.  The Court of Appeals inferred from the parties’ conduct that they agreed to modify the contract and subcontract to compensate the subcontractor for its extra work.  In addition, the subcontractor did not perform its extra work voluntarily or gratuitously; it expected fair compensation.

Thus, the Northern Clearing decision illustrates that a subcontractor who performs non-gratuitous services outside of the scope of the original contract, but at the request of the owner, may still be entitled to fair compensation for its extra work performed even though there is no contract between the parties.  Note: other jurisdictions (e.g., Maryland) have rejected this outcome.

 

COURT COMPELS ARBITRATION BASED UPON “FLOW DOWN” PROVISION IN PURCHASE ORDER

Subcontracts and supply contracts often contain “flow down” provisions that bind the subcontractor to the terms and conditions of the general contractor’s contract with the owner or bind the supplier to the terms and conditions of the subcontract or even the contract between the contractor and the owner.  Generally, courts will enforce these “flow down” provisions and hold subcontractors and suppliers to the terms and conditions of the general contracts and subcontracts.  In Umicore Building Products USA, Inc. v. Trinity Roofing Service, Inc., 2004 U.S. Dist. LEXIS 15472 (N.D. Ill. 2004), the court enforced a binding arbitration provision in a subcontract between the subcontractor and contractor against a supplier based upon a “flow down” provision in the purchase order sent from the subcontractor to the supplier.

In Umicore Building Products, a subcontractor entered into a contract with the general contractor for a portion of the work on a construction project in Chicago.  To carry out this subcontract, the subcontractor entered into a supply contract under which the supplier was to furnish the subcontractor with roofing material.  The supplier delivered the roofing material to the subcontractor.  When the subcontractor failed to pay the supplier, the supplier filed suit against the subcontractor in federal district court alleging breach of contract.

The subcontractor filed a third-party complaint against the general contractor, claiming that if the subcontractor was liable to the supplier then the general contractor was liable to the subcontractor.  The general contractor promptly moved and was granted a motion to stay the proceedings in court and compel the subcontractor to arbitrate the dispute based upon a binding arbitration clause in the subcontract. 

Subsequently, the subcontractor moved to compel arbitration against the supplier based upon a provision in the Purchase Order sent from the subcontractor to the supplier.  The Purchaser Order stated, “Work performed by [supplier] shall be in strict accordance with all applicable plans, general conditions, specifications and addenda thereto, and [supplier] is bound by all provisions of these documents, and also other documents to which [subcontractor] is bound, and to the same extent.” 

The court noted that “when a contract includes an arbitration clause, the clause creates a presumption that the dispute should be arbitrated, unless the party opposing arbitration can show that the clause is incapable of an interpretation that could cover the dispute at hand.”  Based upon the language of the Purchase Order which bound the supplier to the terms of the subcontract, the court held that because the subcontract bound the subcontractor to arbitrate the dispute with the general contractor, the supplier was also bound to arbitrate the dispute.

As Umicore Building Products demonstrates, courts are willing to enforce “flow down” provisions in subcontracts and supply contracts.  For this reason, subcontractors and suppliers should be aware of all “flow down” provisions, and if the contract contains a “flow down” provision, the subcontractors and suppliers should be aware of the terms and conditions of the general contracts and subcontracts that may be imposed upon them by the “flow down” clause.