May 2001 Newsletter

 

Katz & Stone, L.L.P. Construction Newsletter
May/June 2001
Volume XI, Number III

 

VIRGINIA MECHANIC'S LIENS SURVIVE VOLUNTARY CHAPTER 11 BANKRUPTCY PROCEEDINGS

Mechanic's liens have long been recognized in the construction industry as a powerful tool to collect unpaid debts on private work.  This March, the United States District Court for the Eastern District of Virginia confirmed that a mechanic's lien is also a useful tool to improve a contractor's chances of collecting from a bankrupt owner.  See In Re: Concrete Structures, Inc. v. Tidewater Crane and Rigging Co., No. 3:00cv314, 2001 U.S. Dist. LEXIS 3675 (E.D. Va. March 30, 2001). 

In Concrete Structures, a crane and rigging contractor filed a Memorandum of Mechanic's Lien against property owned by Concrete Structures, Inc. (the "owner").  Prior to the contractor filing its Bill of Complaint to Enforce Mechanic's Lien, the owner filed for voluntary Chapter 11 bankruptcy.  Subsequently, the owner filed an adversary proceeding in the bankruptcy court attempting to avoid the lien.  The bankruptcy court dismissed the action affirming the validity of the lien, to which the owner appealed.

In an attempt to avoid the contractor's lien, the owner first argued that the lien constituted a "preference" under the bankruptcy laws and was therefore invalid.  Because "statutory liens" do not constitute "preferences," the federal district court looked to Virginia law to determine if Virginia's mechanic's lien is statutory or judicial in nature.  After looking to Virginia Code § 43-3, the court determined that "Virginia law clearly concludes that mechanic's liens are statutory in nature."  As such, the mechanic's lien did not constitute a preference.

Next, the owner argued that the contractor failed to perfect its lien by instituting an enforcement action within the required period.  The district court rejected this argument as well.  Under federal bankruptcy laws, the court noted that the owner's bankruptcy petition automatically barred the filing of an enforcement action because the filing of a bankruptcy petition stays "any act to create, perfect, or enforce any lien...."  The court also concluded that, by statute, the contractor's lien was perfected upon the filing of the memorandum, not by instituting an enforcement action.

Lastly, the court addressed the owner's argument that the contractor failed to comply with the federal bankruptcy law's provisions which extend the time period for filing some actions and thus, the contractor's lien suit was not timely.  The owner's argument asserted the bankruptcy provisions did not apply because mechanic's liens are actions against the property and not against "a debtor," as the statute prescribes.  The court rejected this argument as well, holding that federal bankruptcy law read in conjunction with Virginia lien law extends the time limit to file an enforcement action until the later of (1) the time provided by the mechanic's lien statute, including the time suspended, or (2) thirty days after the notice of the termination or expiration of the automatic stay.  Consistent with federal law, the Virginia Code further provides that if the filing of a bankruptcy petition obstructs the filing of an action, the time consumed by the obstruction is not counted in the period in which the action should be brought.  Accordingly, the court held that the contractor had until the later of the amount of time left on the statutory lien enforcement period of six months (nearly four months) or 30 days after the lifting of the stay in which to file its enforcement action.

Unpaid Virginia contractors questioning the solvency of a project owner are well advised to file a memorandum of mechanic's lien sooner rather than later.  As Concrete Structures illustrates, the mere filing of a memorandum of mechanic's lien vastly improved the contractor's position (and its chance of collecting) if the owner files for bankruptcy.

 

NEW JERSEY CONTRACTOR DAMAGED BY ITS OWN UNBALANCED BID

Many public construction contracts prohibit the submission of unbalanced bids, i.e., bids which disproportionately allocate contract costs amongst the various line items which make up the contractor's bid price.  In M.J. Pacquet, Inc. v. New Jersey Dept. of Transportation, 761 A.2d 122 (2000), the Superior Court of New Jersey, Appellate Division enforced just such a contract provision and upheld a deductive change order issued by the New Jersey Department of Transportation ("NJDOT") based solely on the value of certain line items as listed in the contractor's bid.

In October 1992, NJDOT solicited bids for a contract to rehabilitate several highways in northern New Jersey.  The project included restoring twelve bridges along the various routes.  The bid specifications required bidders to estimate the cost, overhead, and anticipated profit of each line item.  While the contract was to be awarded to the contractor with the lowest overall bid, the specifications warned prospective contractors that they could not seek additional compensation if their estimates of the individual line items were inaccurate. 

In preparing its initial bid, M.J. Paquet, Inc. ("contractor") received an $826,473.50 estimate from a subcontractor for painting the twelve bridges.  The contractor used that estimate to prepare the forty-four line items in the bid which pertained to painting the bridges.  However, shortly before submitting its bid to NJDOT, the contractor received a much lower estimate (almost half the $826,473.50 original) from a different painting subcontractor.  Given the time limitations, and the effort required to revise the forty-four pay items corresponding to the bridge work, the contractor made no changes to the allocation of costs, overhead, and anticipated profit on the bridges.  Instead, it lowered the price of other pay items in its bid to reflect the cost-savings achieved from new painting subcontractor's price.

Almost eleven months after the contract was awarded, OSHA revised its rules regarding the removal of lead-based paint.  The new OSHA regulations greatly increased the cost of the bridge painting work.  Accordingly, the contractor quickly submitted three claims, ultimately asking for an additional $608,000.00 in compensation.  NJDOT and the contractor engaged in extensive negotiations but could not reach an agreement on the new painting work.  Consequently, NJDOT elected to delete the bridge painting work from the contractor's scope pursuant to a contract provision which permitted NJDOT to solicit new bids for "extra work" when it could not agree on a price with the contractor.  Ultimately, NJDOT hired a new painting contractor and deducted from the contract price the entire amount of the forty-four line items attributable to the bridge painting work as reported on the contractor's bid.

Given that the contractor's actual cost for the painting work was far lower than the amount reported on the bid, the contractor sued the owner for unjust enrichment contending that the deduction was excessive.  In support of its claim, the contractor argued that it was not fair to reduce its contract price by the amount of the individual line items found in its bid.  Instead, the contractor urged the court to use the "equitable adjustment rule" recognized by most federal contracts.  Under that rule, the proper way to recalculate a contract price is to determine the difference between what it would have cost (including overhead and profit) to perform the work pursuant to its original terms versus what it actually cost to perform the changed work.

The court rejected the contractor's arguments and distinguished the ‘equitable adjustment' cases by noting that the parties' contract expressly prohibited submitting "unbalanced bids" (bids where one or more of the line items does not carry its share of the cost of the work).  While the court acknowledged that "unbalanced bids are generally allowed absent a specific prohibition in the public entity's bid specifications or proposal," the court noted that because of the clear contract prohibition in the instant case, it perceived "no injustice" in enforcing the provision in this case.  The court explained that it did "not mean to suggest that [the contractor] harbored an evil or corrupt motive.  Nevertheless, the critical fact remains that [the contractor] flouted the clearly expressed [contract] requirements . . . and that it acted at its peril embarking upon this course.  We merely enforce the contract as written."

The Paquet decision illustrates the financial consequences of submitting an unbalanced bid on a public construction project.  The contractor's up-front decision to take a shortcut in the preparation and submission of its bid likely resulted in the loss of its entire profit on the project.

 

FLORIDA COURT FINDS THAT NO DAMAGES FOR DELAY CLAUSE DOES NOT PROTECT OWNER FROM DAMAGES CAUSED BY ITS ARCHITECT'S BAD-FAITH DELAY

Construction contracts frequently include "no damages for delay" clauses in an attempt to preclude a contractor's recovery of delay-related damages such as extended field and home office overhead.  In Triple R Paving, Inc. v. Broward County, 774 So.2d 50 (Fla. 4th Dist. Ct. App. 2000), a Florida appellate court recognized that a no damages for delay clause is not an absolute bar to a contractor's recovery of delay damages.

In Triple R Paving, Triple R Paving, Inc. ("contractor") entered into a contract with Broward County, Florida ("county"), to widen a portion of Rock Island Road, including widening a bridge which spanned a canal (the "project").  The project was designed for the county by Frederic R. Harris, Inc. ("architect").  The contract between the county and the contractor contained a "no damages for delay" provision, which barred the contractor from making any delay claims against the county, other than for an extension of time.  The contract also contained a "no interest" provision, which stated that the county was not subject to interest for monies due under the contract, but not paid, to the contractor. 

During the course of the project, the contractor encountered three delays to its work.  First, the contractor's completion of the single span bridge was delayed by a horizontal sight distance flaw in the architect's design.  Though the architect was aware of the flaw prior to the construction of the bridge work, and later agreed to check the sight distance against standards, the architect did not correct the flaw in time to prevent the resulting construction delays.  Second, although the architect agreed to coordinate all utility work, a delay in the removal of certain power lines on the project by Florida Power & Light ("FP&L") also delayed the contractor's performance.  Finally, a flaw in the architect's design of a detention pond linked to the canal further delayed the contractor's work, though no proof was presented that the county or the architect was aware of the flaw.  The project was never completely suspended, all work was completed within the extension period granted by the county for the delays, and the contractor was paid for all work it performed.  Nevertheless, the contractor was never able to become efficient in completing its work after the delays and it contended it could not obtain substitute work to compensate it for lost overhead caused by the delays.  Accordingly, the contractor brought suit against the county seeking recovery of damages for inefficiency and extended home office overhead. 

In response, the county argued that the no damages for delay clause of the contract barred all damages for delays not caused by fraud, bad faith, or active interference.  Nonetheless, the jury awarded the contractor damages for loss of efficiency resulting from the delays.  On the other hand, the jury denied the contractor's request for extended overhead costs, and the trial judge denied the contractor's motion for prejudgment interest due to the "no interest" clause of its contract.  Both parties appealed.

The Florida Court of Appeals held that the no damages for delay clause barred recovery for any delay damages not caused by the county's fraud, bad faith, or active interference.  Thus, under the facts of this case, the court concluded that the no damages for delay clause barred the contractor's recovery of damages resulting from FP&L's utility work delay and the detention pond flaw.  On the subject of bridge design flaws, however, the appellate court held that the architect's failure to apprise the contractor of the known horizontal sight distance design flaw constituted bad faith on the part of the county.  As a result, the court held that the contractor's damages resulting from the bridge span delay were not barred by the no damages for delay clause.  Finally, the court held that, by its terms, the "no interest" clause of the contractor's contract barred recovery of interest only on "monies due under the contract," not damages awarded for delays. The court thus held that the contractor was entitled to prejudgment interest on all delay damage awards.

While no damages for delay clauses are widely used in construction contracts, many courts recognize exceptions to enforceability of these clauses under limited circumstances.  The Triple R Paving case is a good example of the types of delays and damages courts will and will not allow when applying a no damages for delay clause.

 

CONTRACTORS WHO FAIL TO ENSURE THAT INSURANCE PURCHASED ON THEIR BEHALF IS PRIMARY RUN THE RISK OF THEIR OWN POLICY COVERING A LOSS

In a recently decided case, a federal district court in Maryland held that two insurance companies were equally liable for covering the loss of a crane where both insurance policies contained an "other insurance" clause which provided that each policy only covered losses not covered by any other policy.  Atlantic Crane Service, Inc. v. S.G. Marino Crane Service, Inc., 2001 U.S. Dist. LEXIS 218 (D.MD. 2001).  For contractors and material suppliers, Atlantic Crane illustrates why it is vital for contracting parties to: (1) expressly designate which party is to bear responsibility for obtaining primary insurance coverage, and (2) actually review any policies obtained for their benefit to ensure conformity with the requirements of their contracts.

In Atlantic Crane, Atlantic Crane Service, Inc. entered into a contract to supply cranes on a private project.  Atlantic Crane, as lessor, subsequently executed a rental agreement with S.G. Marino Crane Service, as lessee, for a crane.  During performance of the project work, the boom on the crane snapped, causing damage to the work and the crane itself.  Citing the "other insurance" clauses referenced above, a dispute arose between the lessor and lessee's insurers over which insurer was responsible for covering the loss of the crane.

Before a federal district court in Maryland, the lessor's insurer argued that the parties to the rental agreement intended that the lessee's insurer be the primary insurer of the crane.  In support of this argument, the lessor pointed to the terms of the rental agreement, which specifically required the lessee to obtain insurance for the crane, and the fact that the "other insurance" clause of the lessor's policy had been added in connection with the rental agreement's execution.  The court rejected this argument, holding that an insurer's liability must be determined by the insurance contract itself, not by the terms of the contract under which such insurance was obtained.  The court then ruled that pursuant to Maryland law, when a conflict occurs between "other insurance" clauses in separate policies, liability is to be shared equally by the insurers as if both were primary.

Atlantic Crane is a representative of what can go wrong when contractors fail to clarify and later ensure compliance with the insurance obligations in their contracts.  To avoid the result obtained in Atlantic Crane, contractors seeking to obtain coverage from another party under contract must make certain that their contracts specify that such insurance be primary and not excess.  Although such a clause would not have likely influenced the court's decision in Atlantic Crane, at the very least, it would have given the lessor a cause of action for breach of contract against the lessee for its failure to obtain primary insurance coverage.  Secondly, contractors obtaining insurance coverage from others pursuant to a contract should review the actual policies themselves to ensure that the insurance being provided complies with their contract.

While many contractors do not focus on insurance provisions during contract negotiations, contractors, with very little effort, can ensure that the coverage scenario in Atlantic Crane does not occur.