July/August 2003 Newsletters

 

Katz & Stone, L.L.P. Construction Newsletter
July/August 2003

 

STATUTORILY-MANDATED SUIT TO ENFORCE MECHANIC’S LIEN DOES NOT WAIVE CONTRACTUAL RIGHT TO ARBITRATE


Contractors who wish to preserve a contractual right to arbitrate disputes, while simultaneously preserving their statutory mechanic’s lien rights, should pay close attention to the timing and manner in which they do so. As illustrated by the case of Hood v. Central Illinois Construction, Inc., 781 N.E.2d 585 (Ill. App. Ct. 2002), a contractor who commences litigation to preserve mechanic’s lien rights before commencing arbitration to resolve the underlying dispute may be found to have waived the right to arbitrate.

In Hood, an owner contracted with a contractor to construct a shopping mall. When a dispute arose between the parties, the contractor filed a mechanic’s lien against the owner’s property. The contractor also commenced arbitration as provided by its contract. Under Illinois law, the owner of liened property has the right to demand that the lienor commence its suit to enforce the lien within 30 days of such demand. Subsequently, the owner filed such a written demand. Complying with Illinois law, the contractor commenced its suit to enforce the lien, and sought a stay of the suit pending resolution of the earlier-initiated arbitration proceeding.

The owner resisted the contractor’s attempt to stay the lien suit, complaining that the contractor waived and abandoned its contractual right to arbitrate when it later filed the mechanic’s lien action pursuant to state law. Conversely, the contractor argued that it did not act inconsistent with the arbitration clause because it requested arbitration before it was forced by the owner to prosecute the mechanic’s lien claim and because it sought an immediate stay of the claim pending arbitration.

Legally, a contractual right to compel arbitration can be waived like any other contractual right. In the context of arbitration, waiver occurs when a party acts in a manner that is inconsistent with the rights afforded by an arbitration clause and indicates an abandonment of that right. Waiver also occurs when a party submits arbitrable issues to a court for decision.

According to the court in the Hood, however, the contractor had not waived the right to arbitrate its claims. The fact that the contractor first sought arbitration and then filed the mechanic’s lien action was not inconsistent with the arbitration clause. Rather, the mechanic’s lien action sensibly protected the contractor’s interest in the property and was initiated only because the owner required the commencement of litigation to enforce the mechanic’s lien. By immediately seeking a stay of the lien action pending arbitration, the contractor preserved the right to compel arbitration.

Parties facing potential disputes that they wish to arbitrate should carefully consider the order in which they proceed. Although filing and perfecting a mechanic’s lien almost certainly does not waive the right to compel arbitration, commencing suit to enforce the mechanic’s lien may waive such right. In certain cases, where commencing suit is required to preserve the mechanic’s lien, the lienor should consider first commencing arbitration then commencing litigation to enforce the mechanic’s lien while contemporaneously seeking an immediate stay of the mechanic’s lien action pending arbitration.

 

VIRGINIA COURT REJECTS OWNERS’ NEGLIGENCE CLAIM
FOR PURELY ECONOMIC LOSSES, BUT VOIDS CONTRACTOR’S WAIVER OF IMPLIED WARRANTIES WHERE WAIVER FAILED TO COMPLY WITH STATUTORY REQUIREMENTS

In recent years, the courts of Virginia have consistently recognized a distinction between the types of damage that may be recovered based on the breach of a contract versus common law negligence. This distinction was affirmed in the case of Weiss v. Cassidy Development Corp., 2003 Va. Cir. lexis 22 (Feb. 21, 2003), which held that an owner could only recover economic losses under a breach of contract, as opposed to a negligence, theory.

In Weiss, owners of residential real estate contracted with a contractor to construct a home. When the work had not been progressed to the owners’ satisfaction, the plaintiffs were assured that the project would be completed by June. The plaintiffs informed the defendants that they would not pay the contract balance until construction was complete. Subsequently, the contractor abandoned the project. When the contractor refused the owners’ demand to finish the project, the owners hired another contractor to complete the work and brought suit against the original contractor for, among other things, negligent construction and breach of implied warranties. The contractor moved to dismiss the suit.

Addressing the owners’ negligence claim first, the court found that a cause of action for negligence is only available when there is a breach of a duty to exercise care for the safety of persons or property. The court concluded that tort law, of which negligence is a part, is not designed to compensate parties for economic injuries suffered as a result of a breach of a duty assumed only by agreement. Here, the owners alleged that the contractor owed them a duty to perform the work in accordance with the contract, including constructing the project within generally accepted industry standards and in a structurally-sound manner, and that they suffered damages as a direct result of the defendant’s breach of that duty. The court determined, however, that the owners’ damages were purely economic, and thus the law of contracts, not tort law, provided the sole remedy for such economic losses. In other words, the only duty between the plaintiffs and the defendant was the duty arising out of the construction contract. Therefore, the court held that, to enforce such duty, the owners must sue for breach of contract, and could not sue for negligence.

Attempting to avoid dismissal of their negligence claim, the owners argued that the contractor was negligent per se because it failed to construct the project in compliance with state and local building code requirements. Rejecting this claim too, the court found that, to state a cause of action for negligence per se, a plaintiff must allege that (a) the defendant violated a statute enacted for public safety, and (b) the harm that occurred was the type against which the statute was designed to protect. The plaintiffs, however, failed to include any of these allegations in their claim. Moreover, the court concluded that the owners could not prove negligence per se because, while the state building code was enacted to protect the health, safety and welfare of the public, the code was designed to protect against personal injuries, not against the sort of economic loss incurred by the owners. Again, the court held, the law of contracts provides the sole remedy for such economic losses.

Having succeeded in dismissing the owners’ negligence claim, the contractor also argued that their breach of warranty claim should be dismissed. The owners brought a claim for breach of the warranty implied in the sale of a new home by Virginia Code § 55-70.1. The contractor argued that the owners, by virtue of a provision in their construction contract, expressly waived all implied warranties established by statutory law.

The court recognized that a contract may modify or waive the warranties implied by § 55-70.1, so long as certain requirements imposed by the statute were met. One such requirement was for the words used to waive the warranties to “state with specificity the warranty or warranties that are being waived.” The court found that the waiver clause in the construction contract, which waived the warranties “provided by § 55.70.1 of the Code of Virginia,” failed to specify the warranty implied by § 55-70.1. Therefore, because of the use of a period rather than a hyphen, the court refused to enforce the waiver clause against the owners’ claim.

In addition to reminding contractors that they cannot sue a contractee in tort for economic losses under Virginia law, Weiss demonstrates that the courts will narrowly interpret and enforce contractual waiver provisions. Therefore, contractors should take care to ensure that their waivers strictly comply with all requirements as to their format and content.

 

ABSENT CONTRACTUAL ALLOCATION OF THE RISK OF DELAY
SUBCONTRACTOR CANNOT RECOVER DELAY DAMAGES FROM A GENERALCONTRACTOR WHO WAS NOT RESPONSIBLE FOR THEIR OCCURRENCE

In In Re: Regional Building Sys., Inc. v. The Plan Comm., 320 F.3d 482 (4th Cir. 2003), a federal court held that under New York law, absent a contract term to the contrary, a subcontractor cannot recover delay damages from its general contractor when the general contractor is not responsible for the delay.

In the underlying dispute, a contractor entered into a contract with the owner of a tract of real property in Staten Island, New York to manufacture, deliver, and install modular housing units on the property. Shortly thereafter, the contractor subcontracted a portion of its work. Under the terms of the subcontract, the subcontractor was required to pick-up the contractor-built housing units from the contractor, transport the units to the project site, and then erect and complete the structures.

Several months into construction, however, the owner experienced financial difficulties and defaulted on a number of payments. Without these payments, the contractor experienced severe cash flow problems. As a result, the contractor could not meet its subcontract obligation to deliver the requisite number of housing units to the subcontractor.

The contractor suspended work under the subcontract, forcing the subcontractor to bear the expense of supporting idle labor and equipment. Almost a year and a half into the project, the owner ceased paying the contractor altogether. Finally, after the owner defaulted on two consecutive payments, the contractor suspended deliveries and thereafter terminated both its prime contract with the owner and its subcontract with the subcontractor.

The contractor then filed for bankruptcy, and the subcontractor brought claims before the bankruptcy court, seeking to recover not only payment for the work it had performed but also to recover certain other expenses, additional damages, delay damages, and interest. In the middle of the trial the contractor’s bankruptcy trustee agreed to pay the subcontractor $718,128.23, which reflected the undisputed portion of the subcontractor’s claim for work actually performed. As no agreement could be reached as to the remaining claims, however, the parties went to trial. In the end, the bankruptcy court held that the general contractor acted reasonably in suspending the work and ultimately terminating its contracts and that, while the subcontractor could recover a relatively nominal amount for its reimbursable expenses and additional damages, there would be no recovery of delay damages and interest.

The subcontractor appealed the bankruptcy court’s holding that it could not recover delay damages from the general contractor, arguing that the contractor’s financial difficulty did not excuse performance of the subcontract. The United States Court of Appeals for the Fourth Circuit disagreed, finding that under New York law, absent a contractual commitment to the contrary, a contractor cannot be held responsible for delay damages incurred by its subcontractors unless it caused or controlled the delay at issue. In short, unless there is a specific allocation of the risk of delay, a general contractor does not impliedly guarantee that its subcontractors will not be delayed by factors outside its control. Turning to the specific facts at issue, the court noted that the contractor’s suspension of work was caused by the owner’s failure to pay the contractor. As a result, the contractor was not responsible for the delays its subcontractor experienced and was not liable for the subcontractor’s delay damages.

Although the court in Regional Building Systems, Inc. applied principles of New York law, its holding reflects the general tendency of courts to leave the cost of a realized commercial risk where it lies in the absence of an express, agreed-upon allocation of that risk.

 

MARYLAND STATE BOARD OF CONTRACT APPEALS ERRS
IN UTILIZING SUMMARY PROCEDURES TO DISPOSE OF A CLAIM IN THE ABSENCE OF ADOPTED RULES AUTHORIZING SUCH PROCEDURES

In the May/June 2003 edition of the Construction Newsletter, we reported that the Maryland Court of Special Appeals decided a case in which it affirmed the Maryland State Board of Contract Appeals’ summary dismissal of a contractor’s claim against the State Highway Administration based on the contractor’s failure to give timely notice of its claim within 30 days after the basis for the claim was known or should have been known. The Court of Appeals, the highest court of Maryland, has recently reversed the Court of Special Appeals’ judgment on two grounds. Engineering Management Services, Inc. v. Maryland State Highway Administration, 2003 Md. lexis 318 (Md. 2003).

First, the Court of Appeals ruled that the Board violated the procedures set forth in its enabling statute by granting summary disposition of the contractor’s claim without adopting procedural rules specifically authorizing and governing the use of summary procedures. The Board’s enabling statute required the Board to adopt regulations governing its dispute resolution procedures. Such procedures could be enacted only by a formal rule-making, which the Board failed to do with regard to summary disposition.

Second, the Court of Appeals disagreed with the Court of Special Appeals’ holding that the failure to provide notice was a jurisdictional issue that deprived the Board of jurisdiction over the claim. In the Court’s view, the issue of whether the contractor provided timely notice after it knew or should have known of the basis for its claim was a factual issue that could only afford the State a defense against the claim if established after a full hearing on the merits. Given the fact-sensitive nature of this issue, the Board’s summary disposition based on the mere review of a documentary record was inappropriate. As a consequence, the Court of Appeals ruled that the Board erred in rendering a decision on the issue of timeliness without a full and fair hearing on the merits.

While the precise holding of the Court of Special Appeals was overturned for these procedural reasons, we believe that its analysis concerning the timeliness of the contractor’s notice still provides a valuable lesson that other courts are likely to imitate under similar circumstances. Therefore, contractors should still take to heart the advice offered in the May/June edition, which is to pay careful attention to every contract’s notice provisions and provide prompt notice of claims as they arise even when such claims have not or cannot be quantified until a later date.