January/ February 2004 Newsletters

• IF YOU DON’T SIGN IT, YOU CAN’T SUE: COURT DISMISSES BREACHOF CONTRACT SUIT BROUGHT BY A NON-PARTY TO THE CONTRACT
  
  
• SUBCONTRACTOR WHO IGNORES ITS SURETY’S INDEMNITY DEMAND HELD TO CEDE SETTLEMENT AUTHORITY OVER ITS COUNTERCLAIMS TO THE SURETY
  
  
• COURT FINDS SUBCONTRACTOR NOT BOUND TO COMPLETE ITS WORK FOR TERMINATED GENERAL CONTRACTOR’S SURETY NOTWITHSTANDING SUBCONTRACT’S INCORPORATION BY REFERENCE OF PRIME CONTRACT
  
  
• CONTRACTOR WHO SUBSTANTIALLY PERFORMS ITS WORK RECOVERS FULL CONTRACT PRICE NOTWITHSTANDING MINOR DEFECTS

 

Katz & Stone, L.L.P. Construction Newsletter
January/February 2004

 

IF YOU DON’T SIGN IT, YOU CAN’T SUE: COURT DISMISSES BREACHOF CONTRACT SUIT BROUGHT BY A NON-PARTY TO THE CONTRACT

The case of Berglund Chevrolet, Inc. v. Thor Incorporated, 2003 Va. Cir. LEXIS 251 (2003) shows that the manner in which parties execute their contracts can have significant consequences. In Berglund, an individual entered into a contract with a contractor, in which the contractor agreed to perform work on three showrooms at car dealerships. Unhappy with the contractor’s work, Berglund Chevrolet, Inc., a corporate owner of the dealerships, sued the contractor, alleging that the contractor breached the contract by installing substandard tile. While the corporate owner was not a named party to the contract for work on the showrooms, the individual who executed the agreement was one of the plaintiff’s officers. The contractor moved to dismiss the suit, claiming that the corporate owner was not a party to the contract and thus could not sue under it.

The following facts were presented to the court. The contact stated that it was designed to facilitate an agreement between “Owner” and “Contractor.” The contract identified the “Owner” by the name of the individual who signed the contract, followed by the words “Berglund Auto Group”. Berglund Automotive Group does not exist. In fact, the showrooms are not owned by the individual, but rather by two corporations in which he is an officer or principal. The “Contractor” was identified by the contractor’s corporate name.

The contract was executed at a meeting attended by the contractor’s president and the individual. The individual executed the contract as “Owner,” signing his name on the Owner line without any reference to either of the corporate entities who actually owned the dealerships at issue. The contractor’s president signed the contract on the Contractor line by writing his company’s corporate name followed by his name and the words “President.”

During the performance of the contract, the individual endorsed change orders in his own name without any reference to a corporate entity or his position as an officer for a corporate entity. The contractor obtained an insurance policy securing Berglund Automotive Group. Throughout the job the contractor sent invoices to “Berglund Automotive Group.” In fact, the contractor’s president testified at trial that he believed he had contracted with the individual who signed the contract, as opposed to the corporate entity who had sued to enforce it.
The court held that the corporate plaintiff could not sue to enforce the contract because it was not made a party to the contract by the individual’s signature. On the facts presented, the court found that the individual had signed the contract in his personal capacity. While the individual may not have intended to contract in a personal capacity, the court held that, if he intended to enter into the contract as an agent for the corporate owner, he should have signed the contract as the officer of such entity. As a result, the court dismissed the plaintiff’s suit.

Courts will not look into the intentions of parties if the contract is unambiguous on its face. Parties entering into a contract must be aware of the capacity in which they, and the other party, are signing the contract. If they are intending to enter into a contract on behalf of their company or business than they must clearly designate this fact in their signature block. Not following the proper formalities and assuming the court will overlook or forgive such conduct at trial can be a costly mistake.

 

SUBCONTRACTOR WHO IGNORES ITS SURETY’S INDEMNITY DEMAND HELD TO CEDE SETTLEMENT AUTHORITY OVER ITS COUNTERCLAIMS TO THE SURETY

A surety settled a lawsuit in which the subcontractor was sued by, and had asserted a counterclaim against, its general contractor. When the subcontractor protested the surety’s actions, the surety moved to enforce the settlement and relied on the fact that under the parties’ indemnity agreement if the subcontractor defaulted, the surety assumed the subcontractor’s subcontract rights, including the right to settle claims arising out of the subcontract(s) at issue.

When issuing performance or payment bonds to subcontractors, sureties typically require that, if the subcontractor breaches its contract with the prime contractor and the bond is triggered, the subcontractor will: (1) indemnify and (2) assign to the surety the authority to settle any claims the prime contractor has asserted against the subcontractor. Also common in such agreements are provisions that, if the subcontractor breaches, the surety assumes all rights to settle subcontract claims. In the case of Bell BCI Company v. Old Dominion Demolition Corporation, 2003 U.S. Dist. LEXIS 22911 (E.D. Va. 2003), a court was asked to decide whether a surety’s right to settle claims against the subcontractor included the right to settle the subcontractor’s counterclaims.

In Bell BCI the prime contractor entered into two contracts, "Contract 4" and “Contract 6," with a sanitation authority (“the Authority”) for the general construction of a wastewater treatment facility. In early 2002, the prime contractor entered into two subcontracts with a subcontractor for certain demolition, dewatering, and other site preparation and excavation work required under Contracts 4 and 6.

The subcontractor’s surety issued performance and payment bonds guaranteeing the subcontractor’s performance under Subcontracts 4 and 6. In consideration for posting the bonds, the subcontractor executed an Indemnity Agreement agreeing to "indemnify and hold harmless Surety from and against all liability, loss, claims, demands, ... damages ... and expenses of whatever kind or nature" incurred by the surety that arose out of the bonds it issued for the subcontractor. The subcontractor also assigned to the surety "the right in its sole and absolute discretion to determine whether any claims under a Bond shall be paid, compromised, defended, prosecuted or appealed." If the subcontractor breached the Indemnity Agreement, that breach would act as an assignment to the surety of the subcontractor’s rights in the subcontracts at issue.

The subcontractor ultimately did not complete its work under Subcontracts 4 and 6, and was terminated. While the prime contractor and subcontractor disputed who was to blame for the events that led to the termination, it was not disputed that the subcontractor breached the Indemnity Agreement when it failed to pay its subcontractors and suppliers for work and materials they supplied to the projects. Moreover, because the subcontractor failed to pay those parties, the surety began receiving payment bond claims. When the surety demanded that the subcontractor indemnify it against those claims, and the prime contractor’s claim, the subcontractor simply ignored the surety’s demand.

Thereafter, the surety negotiated a settlement with the prime contractor. Under the settlement terms, the surety paid the prime contractor $275,000 to resolve all claims and counterclaims in the matter. The subcontractor, having ignored the surety’s demands for indemnity, did not take part in the settlement negotiations.

After the settlement agreement was reached, however, the subcontractor finally jumped to action. It objected to the settlement. The surety thus went to court to enforce the settlement agreement. "

At trial, the court found that the surety was “entitled to stand upon the letter” of the indemnity agreement. The indemnity agreement unambiguously gave the surety "the right in its sole and absolute discretion to determine whether any claims under a Bond shall be paid, compromised, defended, prosecuted or appealed." The court thus found that the surety had the right to settle all claims and counterclaims at issue in the matter, including the authority to settle and resolve not only the prime contractor’s claims against the subcontractor, but also the subcontractor’s counterclaims. The court noted that this result was “commercially sensible” because without that right, “a surety's [ability] to settle would often be ineffective because a prime contractor would likely be unwilling to settle its claims against the surety without also settling any counterclaim[s]” the subcontractor may have.

Bell BCI highlights the importance of understanding your contract agreements. Ignoring demands made by parties you contracted with can come back to haunt you, as it did here, where the subcontractor, by ignoring its surety, ceded to its surety control over its defense and counterclaims. Having done that, it was not allowed to object to the actions the surety took to settle and resolve all matters arising out of the subcontract.

 

COURT FINDS SUBCONTRACTOR NOT BOUND TO COMPLETE ITS WORK FOR TERMINATED GENERAL CONTRACTOR’S SURETY NOTWITHSTANDING SUBCONTRACT’S INCORPORATION BY REFERENCE OF PRIME CONTRACT

When a general contractor is terminated by the owner of a construction project, its subcontractors are left in the lurch. It is not often clear if they must continue performing their work for whomever takes over, or may simply walk away from the project. The recent decision in Carolina Casualty Insurance Co. v. Ragan Mechanical Contractors, Inc., 584 S.E.2d 646 (Ga. App. 2003), lends hope to subcontractors that the choice of whether to stay or go rests with them.

In Ragan, the general contractor entered into a contract with the Dekalb County Board of Education (“Board”) for the construction of a high school. Pursuant to the terms of the prime contract, the general contractor obtained performance and payment bonds issued jointly by two sureties. The general contractor entered into a subcontract with a subcontractor to perform the mechanical work on the project. Work proceeded on the project until the Board issued a stop work directive. At that time, the general contractor directed the subcontractor to cease all work on the project. The subcontractor stopped working, and ultimately never resumed its work. The subcontractor was not paid for all of the work it had performed on the project, even though the general contractor was paid for the work.

Thereafter, the Board terminated the general contractor for default and demanded that the co-sureties discharge their obligations under the performance bond. The co-sureties subsequently entered into a takeover agreement with the Board to complete the prime contract, and engaged the services of a construction manager. The construction manager asked each of the terminated general contractor’s subcontractors to sign a ratification agreement, under which they would agree to complete their work on the project. The mechanical subcontractor declined to sign the ratification agreement, however, instead seeking payment for work already performed on the project from the general contractor and the co-sureties under the payment bond. When the co-sureties refused to pay, the subcontractor brought suit. In defense, the co-sureties argued that the subcontractor had failed to perform its obligation to complete its work under the subcontract. Both parties filed motions for summary judgment, seeking a determination as to the subcontractor’s obligations after the Board’s termination of the general contractor. The trial court held that, upon the general contractor’s termination, the subcontractor had no further obligations under the subcontract. The co-sureties appealed.

The appellate court first affirmed that the Board’s termination of the general contractor also resulted in the termination of the subcontractor’s contract. The court found that nothing in the subcontract expressly obligated the subcontractor to complete its work for the benefit of the co-sureties in the event of the general contractor’s termination. Moreover, the court determined that, even though the subcontract incorporated the general contract by reference, the subcontractor did not thereby agree to be bound to the Board under the subcontract. Rather, the subcontractor’s primary undertaking was to perform its work for the benefit of the general contractor and for the purpose of enabling the general contractor to meet its obligations under the general contract. Toward this end, the subcontract expressly provided that the subcontractor assumed toward the general contractor all of the obligations and responsibilities that the general contractor assumed toward the Board in connection with the mechanical, HVAC and plumbing work on the project, and that the subcontractor agreed to start work when notified by the general contractor and to complete work so as to enable the general contractor to fully comply with the prime contract. Thus, while the general contractor was obligated to the Board to perform work under the general contract, the subcontractor was solely obligated under the subcontract to assist the general contractor in performing that work. As such, the court concluded that, when the Board terminated the general contractor’s obligation to perform, the subcontractor’s obligation to assist in that performance was also terminated.

Finally, the appellate court also rejected the co-sureties’ argument that the subcontractor’s obligations to perform continued because the termination clause in the subcontract had not in fact been triggered. The subcontract’s termination clause provided: “Should [the Board] terminate the [general contract] or any part of the [general contract] which includes the Subcontractor's Work, this [Subcontract] shall also be terminated and Subcontractor shall immediately stop Subcontractor's related Work.” The co-sureties asserted that this clause applied only where the board of education terminated the general contract as a whole, and that the board had not terminated the entire general contract because it wanted to preserve its rights under the performance bond. However, the court held that this argument ignored the plain language of the subcontract’s termination clause, which provided that the subcontract was terminated if “any part” of the general contract involving the subcontractor’s work was terminated. Thus, the Board’s termination of even a part of the prime contract was sufficient to trigger the subcontract’s termination.

Ragan stands for the proposition that, in the absence of an express subcontract provision requiring assent to an assignment of their subcontracts to the general contractor’s surety, subcontractors may not be bound to complete their work for a takeover surety even if the general contract is incorporated by reference into their subcontracts. Subcontractors should be aware of how such an “assignment” provision affects their obligations before agreeing to its inclusion in their subcontracts.

 

CONTRACTOR WHO SUBSTANTIALLY PERFORMS ITS WORK RECOVERS FULL CONTRACT PRICE NOTWITHSTANDING MINOR DEFECTS

Substantial performance is a legal doctrine that courts use to prevent an owner from being unjustly enriched by declaring a contractor to be in breach of contract when the owner has received the substance, but not the letter, of its bargain with the contractor. When contractors have substantially complied with their contract, this doctrine allows them to recover the contact price, less the damages sustained on account of such defects, notwithstanding relatively slight defects in their work.

The case of Mathis Implement Company v. James Eric Heath, 2003 S.D. 72 (2003) demonstrates this concept. Mathis involved a home building project. After the concrete foundation and basement walls were poured the owner became dissatisfied with them. On the inside and outside surfaces, the walls exhibited a honeycomb appearance and a gap existed between the wall and one windowsill. The contractor offered to fix the defects for free, but the owner refused. Subsequently the owner demolished the walls, fired the contractor and brought suit for breach of contract against the contractor.

At trial the contractor provided expert testimony that the walls were suitable to build on and that the defects noted by the owner were cosmetic in nature. The contractor also introduced the testimony of the person who demolished the concrete walls that the concrete was strong. The trial judge found the testimony of the contractor’s expert to be reliable and determined that the walls were of good quality. The contractor then argued that, under the doctrine of substantial performance, it was entitled to the contract price less the cost of repairing the defects and presented evidence that the defects could have been repaired at no additional cost to the owner. The trial court agreed, awarding the contractor the full contract price of $28,033.02, without any reduction for the cost of defects. Since the defects could have been repaired at no additional cost they offered no basis for a reduction in the contract price. The trial court found that despite the minor defects, the contractor had substantially performed the contract.

The holding in Mathis offers contractors some assurance that they have the ability to collect for work performed, even when they encounter difficult owners who refuse to pay on the basis of relatively minor defects. The doctrine of substantial performance provides contractors a theory on which to collect payment for work performed even when they have been unable to resolve minor defects in their work with the owner.