September/October 2003 Newsletters

Katz & Stone, L.L.P. Construction Newsletter
September/October 2003

 

SUBCONTRACTOR MAY NOT DIRECTLY PROSECUTE PASS-THROUGH CLAIM AGAINST OWNER WITHOUT INCLUSION OF CONTRACTOR

Pass-through claims are often used by general contractors to present subcontractor claims to the owner. While it is not uncommon for the general contractor to attempt to minimize its role in the preparation and litigation of these claims, subcontractors should be aware of certain strict legal guidelines which, if violated, may foreclose their right to assert such claims.

In the case of Board of Governors for Higher Education v. Infinity Const. Serv., Inc., 795 A.2d 1127 (R.I. 2002), a contractor entered into a prime contract with an owner. The contract contained an arbitration clause. The contractor subcontracted with a subcontractor for excavation work. Upon encountering differing site conditions, the subcontractor sought additional compensation from the contractor. Attempting to resolve the resulting dispute, the contractor and subcontractor entered into a “liquidating agreement” whereby the contractor assigned to the subcontractor its right to arbitrate with the owner, and the subcontractor discharged all claims against the contractor and agreed to bring its pass-through claim directly against the owner in the name of the contractor.

In accordance with the liquidating agreement, the subcontractor filed a demand for arbitration pursuant to the arbitration clause contained in the prime contract between the owner and contractor. In response, the owner sought and received a permanent injunction against the subcontractor prohibiting the subcontractor from arbitrating the pass-through claim with the owner.

On appeal, the Rhode Island Supreme Court affirmed the trial court’s ruling on the grounds that the subcontractor lacked privity with the owner and that the contractor could not assign to the subcontractor its right to arbitrate with the owner. The court refused to allow the subcontractor’s pass-through claim because the claim was brought directly by the subcontractor, rather than by the contractor. While seemingly cumbersome, this process is necessary because a party may generally only sue another party for breach of contract when there is contractual privity. Because the subcontractor did not have a contract with the owner, the subcontractor could not maintain a breach of contract action against the owner. The subcontractor’s only recourse was against the contractor with whom it contracted.

The Rhode Island Supreme Court also held that the liquidating agreement between the contractor and subcontractor had no bearing on the subcontractor’s ability to arbitrate with the owner. Although courts look favorably on arbitration, arbitration agreements are contractual in nature and a party may not be required to arbitrate with another party unless the clause clearly manifests an intent to do so. In this case, the owner only manifested an intent to arbitrate with the contractor and could not be required to arbitrate with the subcontractor. The contractor could not assign to the subcontractor its right to arbitrate with the owner.

Subcontractors must be aware that only the contractor may sue the owner for breach of contract. Although subcontractors frequently take the lead in this process with regard to the subcontractor’s claims, the action must still be commenced by the contractor.

 

MARYLAND COURT OF APPEALS GREATLY EXPANDS SCOPEOF WORKER’S COMPENSATION COVERAGE FOR WORK-RELATED INJURIES

Until recently, an employer subject to a Maryland Worker’s Compensation Act claim could defend a claim for compensation on the basis that its employee’s injury, while accidental, did not arise out of an unusual activity.

In Harris v. Board of Education of Howard County, 375 Md. 21 (2003), however, Maryland’s highest court reversed the rule established by previous court decisions that an employee must be performing an unusual activity in order for an accidental injury to be covered by the exclusive remedy provisions of the Maryland Worker’s Compensation Act. In so-doing, the court formally adopted the definition of "accident" used in most other states, thereby greatly broadening the scope of injuries covered by the Act.

The employee at issue in Harris, was a school cafeteria worker employed by the Howard County Board of Education. Her responsibilities included preparing student lunches, tending the cash register, cleaning the kitchen, and laundering kitchen linens.

On the day that she was injured, the employee was doing laundry with a co-worker. The two women opened a forty-five pound box of laundry detergent, only to find that the box was infested with cockroaches. The women immediately closed the box and attempted to move it outside. Because the box was very heavy, they could not lift it and had to drag it through the kitchen and out a side door.

Once outside, the employee removed the 45-pound bag of detergent from the box and carried the bag back inside. When she bent down to scoop some detergent into a cup and tie the bag of detergent, however, her back "cracked" and she felt immediate pain. The doctor who treated the employee testified at trial that it was her expert medical opinion, within a reasonable degree of medical certainty, that dragging the heavy detergent box outside caused the employee’s back injury.

The employee filed a worker’s compensation claim, alleging that her back injury was disabling. The Worker’s Compensation Commission agreed, and issued an order finding that the employee was entitled to coverage because she had sustained an injury arising out of, and in the course of, her employment. Her employer, though, appealed that order and asked for judicial review of the Commission’s findings.

Although it was undisputed that the employee suffered her injury while performing her work, the employer argued, and the trial court agreed, that she had not shown she had suffered an “accidental injury” within the meaning of the Worker’s Compensation Act. In support of its arguments, the employer cited a line of Maryland court decisions holding that worker’s compensation claims are only compensable under the statute if the injury arises out of “unusual” work activity. The trial court thus overturned the Commission, reasoning that the injury did not arise out of unusual activity — the employee regularly carried heavy boxes in the course of her work, including boxes of laundry detergent — and thus the injury was not covered by worker’s compensation insurance. The intermediate appellate court, relying on the same line of cases, affirmed the denial of the employee’s claim.

Maryland’s highest court agreed to hear the employee’s final appeal to expressly reconsider the line of decisions where it had held previously that the Maryland Worker’s Compensation Act would only cover an accidental injury if the injury resulted from an "unusual activity." The high court noted that the Act did not expressly require that an injury result from unusual activity, and that this judicially-added requirement (1) was unique to Maryland, (2) had not been applied consistently by Maryland courts, and (3) was at odds with the remedial purposes of the Act. As such the court found that the employee was entitled to worker’s compensation coverage and overruled the line of cases establishing the "unusual activity" requirement. In doing so, the court adopted the definition of accident applied in most other states, which is an “unlooked for mishap or an untoward event which is not expected or designed.”

The Harris decision broadly expands the coverage Maryland employers and employees can expect under the Maryland Worker’s Compensation Act. The decision brings Maryland law in line with the law in the majority of states in that the Act now covers employees accidentally injured in the course of employment, regardless of whether they were performing a usual or unusual activity at the time of injury.

 

NEW YORK COURT HOLDS THAT PARTIES’ COURSE OF DEALING SHORTENED SUBCONTRACT’S REQUIRED NOTICE-AND-CURE PERIOD FROM FIFTEEN DAYS TO THREE DAYS

Most construction agreements entitle the party performing work to receive at least one notice of defects in the work, and to be afforded a set period of time after receipt of such notice in which to cure those defects, before termination. However, as AXA Global Risks U.S. Insurance Co. v. Sweet Associates, Inc., 755 N.Y.S.2d 759 (2003), demonstrates, the course of dealing of parties to a contract may alter or even waive contractual rights to notice and opportunity to cure.

In Sweet Associates, the general contractor on a college library construction project hired a subcontractor, which guaranteed its performance on the project by furnishing a performance bond. Early on in the project, the general contractor found the subcontractor’s work deficient and gave formal notice of default to the subcontractor, pursuant to the terms of the subcontract, warning that the general contractor would terminate the subcontract if the deficiencies in the subcontractor’s work were not cured within the fifteen-day period established by the subcontract. Thereafter, the general contractor, the subcontractor, and the subcontractor’s surety had a meeting, which resulted in a letter from the general contractor to the surety conditionally withdrawing the notice of default but reserving the right to thereafter declare the subcontractor to be in default upon only three days’ notice. Neither the subcontractor nor the subcontractor’s surety objected to the shortened cure period, and the subcontractor continued work on the project. The general contractor later sent two more default notices, containing a mere three-day cure period, and the subcontractor and surety did not object. Finally, in response to the third default notice, the subcontractor informed the general contractor that, due to the general contractor’s failure to pay in a timely manner, its sub-subcontractors were refusing to continue to perform their work. The general contractor then made a demand upon the surety to complete the subcontractor’s remaining work, and the surety complied, again without objecting to the shortened cure period. After the work was finished, the surety brought suit against the general contractor for breach of contract. The general contractor then counterclaimed for damages caused by the surety’s delay in completing the work. The surety thereafter moved for partial summary judgment on the issue of liability due to the general contractor’s failure to comply with the 15-day notice and cure provisions of the subcontract. The lower court granted the surety’s motion, and the general contractor appealed.

Upon review, the New York appellate court noted that, although the subcontract clearly required the general contractor to provide a 15-day written notice to cure before it could terminate the subcontract, there was an issue as to whether, by its actions and omissions, the surety had waived the right to the 15-day cure period. Specifically, the court considered whether there was a waiver of the 15-day notice provision by the surety’s failure to object to the shorter three-day notice provision that the general contractor had unilaterally added to their agreement through the course of the parties’ dealing with defects in the subcontractor’s work. Finding that a waiver may be established by affirmative conduct, or by a failure to act, that demonstrates an intent not to claim a right or entitlement, the court concluded, from the surety’s declarations, acts and failures to object, that there was an intention to waive the contractual 15-day notice provision once the original notice of default was conditionally withdrawn in the general contractor’s letter to the surety. Accordingly, the court held that the lower court’s award of partial summary judgment to the surety had been premature, and reversed that judgment.

Contractors generally trust that the terms of their contracts cannot be modified except by clear written changes agreed to by all parties. However, the decision in Sweet Associates suggests that contractors need to be acutely aware of, and to expressly reject, any conduct by other parties that runs contrary to the obligations and remedies established in the contract. Contractors that fail to do so may find that their contractual rights have been altered, or even waived, by the parties’ course of dealing.

 


INCONSISTENT CONTRACT TERMS FORECLOSE OWNER’S RIGHTS UNDER CONTRACTUAL WARRANTY PROVISION

Parties to contracts should review all contract terms and ensure that all terms are clearly defined and consistently used. In the case of Lee Lewis Construction v. United States, 54 Fed Cl. 88 (2002), the United States Postal Service was unable to recover from its contractor for repair work to a damaged roof under a contractual warranty provision because the terms used in the contract to describe the warrantor were held to apply to a third- party other than the contractor.

In 1987, the Postal Service contracted with a contractor to construct a general mail facility. The contract contained a warranty provision requiring the “roofing contractor” to furnish to the owner a 10-year full value warranty covering labor and materials with an additional 5-year warranty covering only materials. The contractor contracted with a subcontractor to perform the roofing work, who in turn contracted with a supplier to provide the specified roofing materials. The supplier provided a ten-year warranty covering both labor and materials and a fifteen-year materials warranty in compliance with the contract requirements.

Shortly after taking possession in 1988, the Postal Service became aware of multiple leaks in the roof. The contractor was notified and made several attempts to remedy the problem. Ultimately, in 1995, the supplier replaced one-third of the roof pursuant to the warranty. In 1997, a hail storm destroyed the portions of the roof that had not been repaired. The Postal Service requested that the supplier replace the hail-damaged roof. The supplier refused to repair the roof based upon a provision in the warranty that excluded any damage due to hail storms. The Postal Service concluded that the roof was not fit for its intended purpose, contracted with a separate company to replace the roof and demanded payment for the repairs from the contractor based upon the warranty.

The contractor refused to pay for the repairs and filed suit against the Postal Service seeking a declaration that it was not liable for breach of the contractual warranty provisions. The contractor argued that it was not liable for the roof replacement because it was not the party responsible for supplying the roof warranty under the contract. As the contractor pointed out, the contract uniformly referred to the contractor as “the contractor.” In the warranty section of the contract, however, the contract provided that “the roofing contractor shall furnish to the owner the [warranty].” (emphasis added). Accordingly, the contractor argued that the term “roofing contractor” must refer to a third-party to the contract. The court agreed with the contractor holding that the contract clearly required the roofing contractor to furnish the roof warranty and the contractor, according to the terms of the contract, was not the roofing contractor.

This case evidences the need to pay close attention to the language used in a contract. When a contract refers to a party by one term, it will be presumed that the use of a second term was intended by the parties to have a distinction. In Lee Lewis, this commonly-applied rule of interpretation resulted in a contractor successfully avoiding liability under a warranty that was furnished by a third party. Thus, to avoid unintended consequences, parties to contracts should be consistent in the usage of contract terms.