January/ February 2003 Newsletters

• MONTANA SUPREME COURT RULES THAT CONTRACT TERM REQUIRING SUBCONTRACTOR TO WORK “AS DIRECTED” PRECLUDED DELAY CLAIMS
  
  
• MARYLAND COURT REFUSES TO COMPEL ARBITRATION OF DISPUTES WITHOUT SUFFICIENT EVIDENCE OF AN AGREEMENT TO ARBITRATE
  
  
• COURT AWARDS CONTRACT RATE OF INTEREST ON SUBCONTRACTOR’S BOND CLAIM; SURETY’S BOND LIABILITY COEXTENSIVE WITH PRINCIPAL’S CONTRACTUAL LIABILITY
  
  
• COURT LIMITS DAMAGES ASSOCIATED WITH A SUBCONTRACTOR’S ANTICIPATORY BREACH TO THE INCREASED COST OF PERFORMING THE ORIGINAL SUBCONTRACT’S SCOPE OF WORK

 

Katz & Stone, L.L.P. Construction Newsletter
January/February 2003

 

MONTANA SUPREME COURT RULES THAT CONTRACT TERM REQUIRING SUBCONTRACTOR TO WORK “AS DIRECTED” PRECLUDED DELAY CLAIMS

While it is not unusual for carefully drafted subcontracts to contain provisions requiring the subcontractor to complete its work as directed by the general contractor, subcontractors should be careful that, in agreeing to such a term, they are not giving up their right to assert claims for delay. As illustrated by the case of Keeney Construction v. James Talcott Construction, 309 Mont. 226 (2002), a subcontractor’s assent to such a term can have disastrous consequences on the ability to assert delay claims when things do not go as expected.

Keeney involved a project at the University of Montana for the construction of student housing. In August 1996, a subcontractor submitted a bid to a general contractor to perform the project’s site work. The general contractor was awarded the prime contract, which contained an initial completion date of May 1997. On August 27, 1996, after the prime contract was awarded, the subcontractor and general contractor attended a preconstruction meeting during which the general contractor presented a preliminary schedule showing a September 3, 1996 start date and a December 1996 finish date. According to the subcontractor, the completion date of December 1996 was specifically discussed at the meeting. Two days later, the subcontractor and general contractor entered into a subcontract under which the subcontractor agreed to prepare the initial site, install water and sewer lines, prepare subgrade for roads and parking areas, and pour concrete curbs, gutters and sidewalks. The subcontract required the subcontractor “to complete the work of this subcontract as required by job progress or within the following time limits: As directed by James Talcott Construction, Inc. [the general contractor]” (Emphasis added).

On September 10, 1996, the project architect wrote the general contractor, stating that the owner did not want an early completion of the project and requesting that the general contractor prepare an official schedule reflecting final completion on May 31, 1997. Shortly thereafter, the owner and general contractor executed a change order extending the completion date by a month, to June 30, 1997, and then added three additional housing units to the general contractor’s scope of work, extending the overall completion date to July 31, 1997. While there was some dispute as to when the subcontractor completed its work, on October 1, 1997, the architect issued the Certificate of Substantial Completion for the project.

The subcontractor subsequently sued the general contractor for delay damages, arguing that the parties to the subcontract agreed to an early completion date in December 1996. The trial court granted partial summary judgment against the subcontractor on its delay claim. The subcontractor appealed.

On appeal, the primary issues revolved around the propriety of the subcontractor’s delay claims. The first issue was whether the parties intended that the subcontractor complete its work by late December 1996. On this point, the court found the subcontract to be unambiguous. The court found that the subcontract “clearly state[d] that [the subcontractor] agreed to work at the direction of [the general contractor]” and authorized the general contractor to set the subcontractor's completion schedule. If the parties had wished to memorialize an agreement as to a December 1996 completion, they could have easily included this date in the subcontract. Because the subcontract was not amended to reflect a December completion, the subcontractor could not recover for delays based on such completion date.

The next issue addressed by the court was whether the “as directed” clause in the subcontract also barred the subcontractor’s claims for delays extending past the original May 31, 1997 completion date. Noting that there was no clear consensus among courts addressing the issue of whether a subcontractor working “as directed” may seek damages for delay, the court ruled that the “as directed” clause precluded the subcontractor’s right to recover any delay damages because it clearly gave the general contractor the right to direct the timing of the subcontractor's work.

Although there is no national consensus as to whether a contract provision requiring a subcontractor to work “as directed” by the general contractor will preclude delay claims, the rationale behind the Montana court’s decision should be noted by construction professionals everywhere. General contractors could use or insert similar contractual language as a defense to any subcontractor delay claims, while subcontractors who are not willing to risk losing such potential claims should have a specific plan to negotiate or amend the contract to reflect the parties’ mutual understanding of the clause as it relates to delay claims.

 

MARYLAND COURT REFUSES TO COMPEL ARBITRATION OF DISPUTES WITHOUT SUFFICIENT EVIDENCE OF AN AGREEMENT TO ARBITRATE

Many construction contracts obligate parties to arbitrate their disputes, either as a condition precedent or as an alternative to litigation. As RTKL Associates, Inc. v. Baltimore County, 2002 Md. App. LEXIS 190 (2002), demonstrates, however, courts are reluctant to compel parties to engage in arbitration without clear and express evidence that both parties agreed to submit their claims to that dispute resolution process.

In RTKL, an architectural firm submitted a proposal to a Maryland county to perform architectural services for a nature park. The proposal provided that the firm’s fees would be based on the American Institute of Architect’s Contract Form B-141 (“AIA B-141”). AIA B-141 contains a provision requiring mandatory binding arbitration of all disputes arising out of or relating to the contract. After the county accepted the firm’s proposal, the parties executed a contract provided by the county, attaching the firm’s proposal as an appendix and incorporated it into the contract under the heading “Scope of Work.” The contract also contained a “Disputes” clause calling for binding arbitration, although the county crossed out the clause prior to execution of the contract.

When a dispute arose as to certain grading work, the county filed suit against the firm in state court. The firm moved to compel arbitration, but the motion was denied. On appeal, the firm renewed its argument that the parties had agreed to arbitrate their disputes and, therefore, arbitration of the grading work dispute should be compelled. In its view, when the parties incorporated the firm’s proposal into the contract, they also incorporated the AIA B-141 referenced in the proposal and, thus, the AIA B-141's arbitration requirement as well. Then, in deleting the “Disputes” clause from the contract, the parties indicated their agreement that the AIA B-141’s arbitration clause was to serve as the governing dispute resolution provision.

The court disagreed with the firm’s arguments. While arbitration of disputes is favored and encouraged, it can only be utilized if the parties have voluntarily agreed to substitute such a process for litigation. Therefore, when parties to a contract contest whether arbitration is the appropriate dispute resolution process, courts can and must decide only one issue: whether there is an enforceable agreement to arbitrate the dispute. To resolve that issue, courts look primarily to the contract language, but, above all, will consider what a reasonable person in the position of the parties would have thought the contract required.

The court found that the firm, in submitting its proposal, contemplated that the parties would ultimately use an AIA B-141 form contract. Ultimately, however, the county used, and the firm accepted, a different contract form. Moreover, the firm’s proposal, the majority of which concerned the firm’s scope of work, was only incorporated into the contract’s scope of work provision, not into the contract’s disputes or arbitration clause. Furthermore, the court was not persuaded that a reasonable person would interpret the county’s striking of the “Disputes” clause in its own form contract as an implicit agreement to the arbitration provisions of AIA B-141. Finally, noticing that other provisions of the final contract had been deleted and replaced, the court concluded that the mere deletion of the “Disputes” clause, without modification, indicated that the parties did not intend to arbitrate their disputes.

The court then also rejected the county’s claim that the firm should be sanctioned because their appeal of the arbitration issue was not substantially justified under the facts and applicable law. The court held that the mere fact the appeal was not successful did not warrant a finding that the appeal was improper or brought only for the purpose of harassment or delay. The court was also not convinced based on the record that the firm unreasonably believed that its claim was meritorious or generated legitimate issues of fact.

As RTKL shows, courts are hesitant to require arbitration of disputes absent reasonable certainty of an agreement to arbitrate. In RTKL, the incorporation by reference of a proposal in the “Scope of Work” section of a contract was not sufficient to convince a court that the parties agreed to arbitrate. The firm could have better indicated its intent to arbitrate disputes by expressly specifying arbitration in the contract’s “Disputes” clause or, at a minimum, by referencing the proposal or the arbitration provision of AIA B-141 in that clause.

 

COURT AWARDS CONTRACT RATE OF INTEREST ON SUBCONTRACTOR’S BOND CLAIM; SURETY’S BOND LIABILITY COEXTENSIVE WITH PRINCIPAL’S CONTRACTUAL LIABILITY

As a general proposition, a surety’s liability under a payment bond is measured by the liability of the contractor (or principal) furnishing the bond. One of the key factors a court will consider therefore in determining the scope of a surety’s obligation is the terms of the contract. In the case of Suamico Sanitary District No. 1 v. Midwest Contractor’s, Inc., 650 N.W.2d 561 (Wisc. App. 2002), a court applied these principles to a subcontractor’s bond claim for interest on unpaid requisitions.

In Suamico, a suburban sanitary commission, as owner, contracted for the construction of a sewer extension. Consequently, the contractor posted a payment bond on the project. Pursuant to the payment bond, the surety promised to pay amounts owed to subcontractors for labor and materials furnished in the event the contractor defaulted.

The contractor contracted with a subcontractor to perform certain work on the project. The subcontract contained a payment provision wherein payment was to be made within ten days of requisition, with a 1.5% monthly service charge imposed against late payments. After the subcontractor completed the project, the contractor failed to make final payment.

Litigation broke out once the owner of the project sued the contractor for default. Because the contractor had not paid the subcontractor, the owner made the surety and the subcontractor parties to the suit. The trial court awarded the subcontractor the unpaid balance owed by the contractor, but denied the subcontractor’s claim for interest.

On appeal, a higher court affirmed the trial court’s award of the unpaid balance, but reversed its decision with regard to interest. In reaching its decision, the appellate court first noted that a surety’s obligation is derived from its principal, and the liability of the surety is measured by the liability of the principal. Examining the subcontract, the court found that the subcontractor was entitled to recover interest. The court also noted that the bond itself did not exclude claims for contract interest. Therefore, because the contractor and subcontractor agreed to the payment of interest on labor and materials furnished and such interest was part of the indebtedness covered by the bond, the surety was liable for interest owed to the subcontractor.

As the court’s decision in Suamico demonstrates, a surety’s payment bond liability is generally coextensive with the contractual liability of its principal, unless expressly limited by the bond itself. When making a claim against a payment bond, subcontractors may therefore pursue against the surety all contractual claims they have against the contractor for labor and materials furnished, unless it is clear from the terms of the bond itself that a particular claim has been excluded from the scope of coverage.

 

COURT LIMITS DAMAGES ASSOCIATED WITH A SUBCONTRACTOR’S ANTICIPATORY BREACH TO THE INCREASED COST OF PERFORMING THE ORIGINAL SUBCONTRACT’S SCOPE OF WORK

In Mashack v. Superior Management Services, Inc., 2002 D.C. App. LEXIS 541 (2002), a contractor subcontracted for the repair of 12 steel sidewalk grates and the replacement of 38 other sidewalk grates with new stainless steel grates. Prior to commencing work, the parties discussed the possibility of using carbon steel, instead of stainless steel, replacement grates. The total cost for carbon steel grates would be more due to the increased labor costs associated with the fabrication process required by such grates. Ultimately, the contractor orally directed the subcontractor to proceed with the carbon steel grates in lieu of stainless steel; however, the subcontractor refused to comply. The contractor then sent a letter to the subcontractor demanding confirmation of the subcontractor’s intent to perform and, after receiving no response, terminated the subcontractor.

The contractor entered into a replacement subcontract to perform the terminated subcontractor’s work. The replacement subcontractor ultimately replaced all 50 grates with carbon steel grates, instead of replacing 38 and repairing 12 stainless steel grates as originally anticipated, for the sum of $133,000.00.

The contractor sued the original subcontractor for breach of contract. The subcontractor contested the suit, alleging that its failure to confirm its intent to perform did not constitute a breach and that the contractor had itself breached the contract by entering into a replacement subcontract with another subcontractor to perform the work.

The trial court ruled in favor of the contractor, finding that the original subcontractor had committed an anticipatory breach of the contract by refusing to perform and by subsequently failing to confirm that it would perform. As such, the contractor was allowed and, indeed, well-advised to find another party to perform the work.

Having found the subcontractor liable for breach, the trial court awarded the contractor $33,580. The court arrived at this number by subtracting the original subcontract price with the subcontractor, $67,500, from the adjusted replacement subcontract price, $101,080. The adjusted replacement subcontract price was calculated by reducing the total replacement subcontract price of $133,000 by 24% in order to account for the fact that the original subcontract called for the replacement of only 38 grates and the alternate subcontract called for the replacement of all 50 grates.

On appeal, the subcontractor argued that the trial court’s award of $33,580 failed to take into account that the replacement subcontract called for a different, more expensive fabrication process due to the use of carbon steel grates. The appellate court agreed, affirming the judgment in favor of the contractor, but remanding the case back to the trial court to reconsider the amount of damages awarded. The appellate court recognized that the measure of damages for breach of contract is the amount necessary to place the nonbreaching party in the same position as if the breached contract had been performed. Had the original subcontractor been required to use the carbon steel grates, it would have been entitled to a change order for the extra costs. Likewise, had the replacement subcontractor used the less expensive stainless steel grates as required by the original subcontract, its price would have been less.

The Mashack case sheds light on several issues related to the decision to terminate a subcontractor. First, in many jurisdictions, a clear refusal by a party to perform a contract may be treated as an anticipatory breach by the other party to the contract. In such a situation, terminating a subcontractor and hiring a replacement subcontractor may be justified. Second, courts will seek to place a contractor in the same position as if the original subcontract had been performed. Thus, a contractor will not be able to recover costs attributable solely to the expansion of the scope of work of the replacement subcontract.