March/April 2006 Newsletters

• TENNESSEE COURT HOLDS LIQUIDATED DAMAGES CLAUSEVIOLATES PUBLIC POLICY WHERE CALCULATIONSNOT BASED UPON A REASONABLE ESTIMATE;MISTAKEN BID CANNOT BE REFORMED UNLESS MUTUAL MISTAKE
  
  
• CONTRACTOR’S LIEN HELD INVALID FOR FAILURE TO FILE BOTH ITS MEMORANDUM OF MECHANIC’S LIEN AND ITSCERTIFICATION OF MAILING TO PROPERTY OWNER AT THE SAME TIME
  
  
• MASSACHUSETTS COURT RULES THATCONTRACTUAL FORUM SELECTION CLAUSE PERMITSLITIGATION IN RHODE ISLAND, BUT DOES NOT MANDATE IT
  
  
• NEW YORK COURT FINDS THAT A SURETYWHO ISSUED A LABOR AND MATERIAL BOND IS LIABLETO WORKERS EVEN THOUGH THE WORKERS WERE ON STRIKE

 

Katz & Stone, L.L.P. Construction Newsletter
March/April 2006

TENNESSEE COURT HOLDS LIQUIDATED DAMAGES CLAUSEVIOLATES PUBLIC POLICY WHERE CALCULATIONSNOT BASED UPON A REASONABLE ESTIMATE;MISTAKEN BID CANNOT BE REFORMED UNLESS MUTUAL MISTAKE

The case of Eatherly Construction Co. v. HTI Owner, 2005 Tenn.App. LEXIS 575 (Tenn.App. 2005) demonstrates two important principles: (1) even if parties agree to a liquidated damages amount, a court may deny a claimant liquidated damages if the stipulated amount is not based upon a reasonable estimate, and (2) even where a contractor submits a mistaken bid which is incorporated into the contract, a court will not reform the contract unless the owner knew or should have known of the bid error.

In Eatherly Construction, an owner contracted with a contractor to construct a water line and pumping station for a new acute care hospital. The contract included a liquidated damages provision which stated that the contractor must pay the owner $500 for each day that the contractor was late in completing the project. In addition, unbeknownst to both parties, the contractor miscalculated its bid, underbidding by $35,250; this mistake was incorporated into the total contract price.

During construction, the contractor realized its bid mistake and demanded that the owner pay the extra $35,250, to which the owner declined. Accordingly, the contractor filed suit and demanded the $35,250 that it had lost due to its miscalculation. The owner counterclaimed under the liquidated damages clause for $27,250 as the contractor was 55 days late in completing the project. The trial court struck down the liquidated damages claim of $500 per day because the owner had not met its burden of proving that the liquidated damages amounts were a reasonable estimate of the requisite damages.  In addition, the trial court dismissed the contractor’s reformation claim finding that there was no mutual mistake.

On appeal, the Tennessee Court of Appeals upheld the trial court’s decision. Even though the parties had freely contracted for the liquidated damages provision and the actual damages were speculative, the Court of Appeals still found that the owner had the burden of proving that the liquidated damages represented a reasonable estimate of the owner’s loss at the time the contract was drafted. Mere agreement between the parties on a dollar value is not enough; the parties must actually perform some minimal calculations or use some benchmark for determining liquidated damages. The Court of Appeals found that the owner did not provide enough evidence to demonstrate that the calculations used in creating the $500 per day amount were based upon a reasonable estimate of the damages to be sustained by the owner. As such, the Court of Appeals struck down the liquidated damages clause as an illegal penalty clause which was void for public policy and dismissed the owner’s claim.

As to the contractor’s bid mistake, the Court of Appeals found that the contractor did not prove by clear and convincing evidence that there was a mutual mistake between the parties which would entitle the owner to reform the contract.  Although equitable principles might dictate that a mistake on the part of both parties might give rise to reformation of the contract price, the Court of Appeals found that the owner was not operating under any misconceptions with regard to the contract terms and had made no mistake.  In order for any court to reform a contract price for mutual mistake, the difference between the mistaken contract price and the actual contract price must be so obvious as to put the parties on notice that the contract contained an error—as an example, the Court of Appeals noted that a difference of 75% might be enough to reform the contract.  Here, the contractor’s miscalculation was only 5% lower than its intended bid amount and only 4% lower than the next bidder.  The owner was never deemed to have known or should have known that the contractor submitted an erroneous bid.  Accordingly, the Court of Appeals found that the contractor did not satisfy the aforementioned burden of proof, and as a result, its contract reformation claim was dismissed. 

Eatherly Construction exhibits two important principles found in construction law.  Even though liquidated damages clauses are rarely struck down for violating public policy, a court may dismiss a liquidated damages claim if the contracting parties did not use some minimal calculations which show a reasonable estimate of damages at the time of contract formation.  In addition, the burden is solely on the party enforcing the liquidated damages clause to prove the reasonableness of the estimation.  Finally, it is important for contractors to review all bids carefully as courts will only reform/correct a mistaken bid incorporated into a contract where the owner knew or should have known of the bidding error.

CONTRACTOR’S LIEN HELD INVALID FOR FAILURE TOFILE BOTH ITS MEMORANDUM OF MECHANIC’S LIEN AND ITSCERTIFICATION OF MAILING TO PROPERTY OWNER AT THE SAME TIME

Under Virginia mechanic’s lien law, a mechanic’s lien will be held invalid if a general contractor fails to file its memorandum of lien with its certification that a copy of the memorandum has been mailed to the property owner.  This lesson is illustrated in the recent Virginia Supreme Court case of Britt Constr., Inc. v. Magazzine Clean, LLC, 271 Va. 58 (Va. 2006). 

In this case, a property owner hired a general contractor to construct a commercial carwash facility.  After a dispute arose between the owner and the general contractor, the general contractor filed twelve separate memoranda of mechanic’s liens against the owner’s property between June and October of 2004.  However, the general contractor did not file its certifications of mailing at the time of filing the mechanics’ liens; the general contractor waited until December 2004 to record the certifications of mailing.

The owner filed a petition to invalidate the mechanic’s liens and argued that the liens failed to meet the perfection requirements under the Virginia mechanic’s lien statutes.  Specifically, the owner asserted that the liens were invalid because the general contractor failed to mail copies of the memoranda of mechanic’s liens to the owner or file certifications of mailing along with the memoranda. 

The general contractor argued that the relevant mechanic’s lien statute, which directs a general contractor to file a certification of mailing, is not a requirement for perfection of the general contractor’s mechanic’s lien; the statute’s only requirement for the perfection of a mechanic’s lien is the timely filing of the memorandum of lien.  Further, the general contractor argued that the certification of mailing is only necessary to ensure the property owner is deemed to have notice of the lien.  As such, the general contractor maintained that the requirement for filing a certification of mailing is merely a notice provision that should be construed liberally. 

Disagreeing with the general contractor’s interpretation of the mechanic’s lien statute, the court found that the certification of mailing requirement is plain and unambiguous.  The statute expressly requires a general contractor to “file” a certification that the general contractor has mailed a copy of the memorandum of lien to the owner along with the memorandum of lien.  The court noted that the use of the word “file” in that statute makes it clear that the certification of mailing is not merely a notice provision.  Accordingly, the court determined that the statute directs that a memorandum of lien cannot be filed without the certification of mailing; both documents must be filed in order to perfect the lien. 

The court noted that the general contractor’s interpretation of the statute would allow a general contractor to mail a copy of the memorandum of lien and file the certification of mailing at a time of its own choosing.  This would undermine the purpose of the mechanic’s lien statute which was designed to prevent a general contractor from filing undisclosed liens against an owner’s property.  Therefore, the court invalidated the general contractor’s liens because of the general contractor’s failure to comply with the statutory certification requirements. 

As a result of this case, Virginia general contractors must file certifications of mailing contemporaneously with their memoranda of mechanic’s liens to ensure that their liens are valid.

MASSACHUSETTS COURT RULES THATCONTRACTUAL FORUM SELECTION CLAUSE PERMITSLITIGATION IN RHODE ISLAND, BUT DOES NOT MANDATE IT

Parties to construction contracts often include a forum selection clause in order to predetermine the venue of any litigation or arbitration proceedings arising from a claim under the contract.  However, as the decision in Dorel Steel Erection Corp. v. Capco Steel Corp., 392 F. Supp. 2d 110 (D. Mass. 2005) demonstrates, if the forum selection clause is not carefully written, it may not set the limits that a party intended.

In Dorel Steel, the subcontract included a provision which stated, “This Agreement shall be construed and enforced in accordance with the laws of the State of Rhode Island. In any litigation connected with this Agreement, the parties hereto hereby consent to and confer jurisdiction on the courts of the State of Rhode Island . . . and on the United States District Court for the District of Rhode Island, and hereby expressly waive any objections to venue in such courts.”  When the subcontractor filed suit in Massachusetts Superior Court, the general contractor moved to dismiss the claim; the general contractor argued that the subcontractor should have filed its complaint in a Rhode Island state or federal district court as required by the forum selection clause.  In response, the subcontractor contended that the clause was permissive; and therefore, it was free to bring suit in Massachusetts where the parties had their principal places of business.

The court determined that it had to interpret the forum selection clause using the standard principles of contract law—unambiguous terms are to be given their plain and ordinary meaning; a contract is ambiguous only when it is reasonably and clearly susceptible of more than one interpretation. 

As such, the court first held that the aforementioned clause which conferred jurisdiction on Rhode Island courts was unambiguous; it did not expressly prohibit litigation in the courts of any other state, nor did it mandate that all litigation take place in Rhode Island. Therefore, the only reasonable interpretation of this provision was that the parties merely agreed to permit each other to litigate matters related to the contract in Rhode Island courts. The court then held that the clause which stated that the parties waived any objection to venue in Rhode Island courts was also unambiguous. The only reasonable interpretation of this phrase was that the parties agreed not to object to any

litigation brought in Rhode Island courts on the basis of venue.

The court concluded that the plain and ordinary meaning of the forum selection clause indicated that it was permissive in nature, not mandatory; the parties did not include language in the clause to the effect that Rhode Island was the only forum in which claims could be brought. To be mandatory, a forum selection clause must contain language that clearly designates a forum as exclusive. Permissive forum selection clauses, by contrast, merely confer jurisdiction on a forum without prohibiting a party from bringing suit in another appropriate forum.  The court determined that the parties could have made the forum selection clause mandatory by conferring jurisdiction “solely,” “only” or “exclusively” on Rhode Island courts or providing that all litigation must be brought within Rhode Island.  However, in this case, the parties did not include such language in the forum selection clause.

As Dorel Steel shows, parties to a construction contract who desire litigation or arbitration proceedings to occur in a particular location only must be sure that the language of their forum selection clause is mandatory, not permissive.  Otherwise, they may find themselves in a jurisdiction not of their choosing.

 

NEW YORK COURT FINDS THAT A SURETYWHO ISSUED A LABOR AND MATERIAL BOND IS LIABLETO WORKERS EVEN THOUGH THE WORKERS WERE ON STRIKE

Generally a labor and material bond only guarantees a subcontractor’s payments to its employees for work in furtherance of the contract.  However, as Morin v. Empiyah & Co., 389 F. Supp. 2d 506 (S.D.N.Y. 2005), demonstrates, a surety may be responsible for the time that the workers are on strike and no work is being performed.

In Morin, a contractor hired union workers to perform carpentry work on the project. The contractor and workers were both parties to a collective bargaining agreement (the “CBA”). The CBA required the contractor to pay specified wages and fringe-benefit contributions.  The CBA also granted the workers the right to strike the job of any delinquent contractor.  Furthermore, the delinquent contractor would be responsible for the workers’ wages for up to three strike days if the workers were to strike because of non-payment.

The surety issued a labor and material bond (the “Bond”) for the benefit of the contractor as principal.  Specifically, the Bond provided that every claimant who had not been paid could sue on the bond for such amounts which may be justly due.  The Bond defined a claimant as “one having a direct contract with the Principal . . . for labor, material, or both, used or reasonably required for use in the performance of the Contract.”

After construction commenced, the contractor fell behind in its payment of fringe-benefits to the workers.  Thereafter, the workers, attempting to cash their paychecks, discovered that there were insufficient funds to cover the checks.  The workers immediately staged a strike for the final two hours of the day.  The strike continued for the next three work-days.

As a result, the workers sued the contractor and the surety for unpaid wages and fringe benefits for the work actually performed by the workers, as well as for compensation for the strike days.  A default judgment was entered against the contractor in favor of the workers due to the contractor’s failure to appear.  The workers then filed for summary judgment against the surety. 

The surety argued that it was not responsible for the days the workers were on strike.  Specifically, under New York law, contractors on a public project are required to obtain a bond insuring payment due all workers who furnish labor to the contractor.  Accordingly, the surety argued that it should not be responsible for the days the workers were on strike because the strike did not further the work on the project.

The court first noted that the minimum protections of New York law should not be read as a bar to recovery for greater protections negotiated by the parties especially where workers were striking due to the contractor’s non-payment of wages.  Also, the court found that claims on payment bonds are conditioned upon whether labor or materials have been furnished and not whether the work was actually performed.  As such, the workers were entitled to be paid for the work they had furnished even though they did not actually perform the work because of the strike. Therefore, there was no statutory bar to recovery for the strike time.

The surety then argued that the terms of the bond itself did not expressly require the surety to pay for the days the workers were on strike.  The court noted that the bond allows a claimant who has not been fully paid to sue for such sums as may be justly due.  Because the claimant had a direct contract with the principal/contractor for labor and materials, the bond expressly granted the workers the right to sue the surety for sums justlydue under the CBA.  As such, the surety was liable to the workers to the same extent that the contractor was liable; the surety was required to compensate the workers for the three work-days in which they were on strike.

As Morin demonstrates, a surety may be liable to a principal’s/contractor’s workers where the workers go on strike even if no work is performed in furtherance of the principal’s/contractor’s contract.  Accordingly, those who are required to furnish a bond for such a project should be aware of the scope of the surety’s responsibilities in the event that the workers go on strike due to the principal’s/contractor’s inability to compensate the workers.