November 2000 Newsletters

 

Katz & Stone, L.L.P. Construction Newsletter
November/December 2000
Volume X, Number VI

 

CONTRACTORS HELD CRIMINALLY LIABLE FOR MISREPRESENTATION OF COMPLIANCE WITH DBE REQUIREMENTS

On public projects, general contractors are often required to comply with government participation requirements designed to foster the development of "disadvantaged business enterprises" ("DBEs").  Compliance with DBE requirements can be challenging and difficult.  In United States v. Brothers Construction Company of Ohio, 219 F.3d 300 (4th Cir. 2000), the United States Court of Appeals for the Fourth Circuit reinforced the severe consequences which can result from misrepresentation of compliance with DBE participation obligations.

In Brothers, Tri-State Asphalt Corporation, the general contractor, and its subcontractor, Brothers Construction Company of Ohio, a certified DBE, misrepresented their compliance with certain DBE participation requirements on a federally-funded highway construction project in West Virginia.  Brothers entered into an agreement with a non-DBE subcontractor working on the project whereby the non-DBE subcontractor utilized Brothers' subcontractor's name as though it had actually performed a portion of the project work.  In exchange, Brothers received payment of $10,000.00.  In fact, the non-DBE subcontractor performed all of Brothers' scope of work.  During construction, when a government inspector attempted to verify that Brothers had actually performed its scope of work, Brothers attempted to conceal its arrangement with the non-DBE subcontractor and, in the process, falsely represented to the inspector that it had actually performed the work.

Although the general contractor was not initially aware of the arrangement between Brothers and the non-DBE subcontractor, the general contractor made no independent effort to ensure that the DBE requirements were met during construction.  Moreover, even after it became aware of Brothers'  arrangement  with  the  non-DBE  subcontractor, the general contractor also falsely represented to the government that Brothers had completed its portion of the work.

The misrepresentations of the general contractor and the certified DBE in Brothers resulted in their criminal prosecution and conviction for multiple criminal charges, including conspiracy to defraud the United States, wire fraud, and making a false statement to the government.  As a sentence, the trial court imposed a fine of $500,000.00 against the general contractor.   The president of the DBE was also convicted individually.

On appeal, the Fourth Circuit Court of Appeals was wholly unsympathetic to the general contractor's argument that the severity of its sentence was undeserved due to the fact that it ultimately satisfied all DBE requirements on the project by reallocating work to other DBEs.  The appellate court found that the general contractor's involvement in a scheme to divert money to a non-DBE subcontractor merited the fine imposed, regardless of subsequent efforts to comply  with  DBE  requirements.   As  for  Brothers,  its certification as a DBE was revoked and it escaped the imposition of fines only because of insolvency.

As Brothers illustrates, misrepresenting compliance with DBE participation requirements can lead to criminal convictions, crippling fines, individual liability and a loss of DBE status.  Moreover, any contractor convicted of fraud or a criminal offense in connection with obtaining or performing a public contract may also be subject to suspension or debarment.  Given these severe consequences, contractors would be well-advised to steer clear of "creative" solutions to meeting DBE participation requirements which promote form over substance.

 

4TH CIRCUIT FINDS ARBITRATION AGREEMENT INCORPORATED BY REFERENCE

Construction contracts often incorporate other documents and agreements by reference.  However, even sophisticated parties may overlook or fail to appreciate the significance of contradictory contract provisions which are incorporated by reference.  This was precisely the situation in the recent case Kvaerner ASA v. The Bank of Tokyo-Mitsubishi, Ltd., 210 F.3d 262 (4th Cir. 2000).

In Kvaerner, the owner entered into a turnkey design and construction agreement with a joint venture general contractor for the purpose of building a waste-to-energy plant in Fayetteville, North Carolina.  To facilitate construction, the individual members of the joint venture executed certain Guaranty Agreements for the benefit of the construction lenders which guaranteed the joint venture's performance of the construction contract.  While the Guaranty Agreements did not specifically provide for arbitration of disputes between the individual joint venturers and the banks, the Agreements did provide that the individual joint venturers had the same "rights and remedies" that the joint venture had under the construction contract.  Under the construction contract, the joint venture had the right to arbitrate disputes "arising out of or relating to" the construction contract.

After the owner took possession of the project, a dispute arose as to whether the joint venture had in fact achieved substantial completion.  Subsequently, the lenders filed an action against the individual joint venturers in federal court in New York State alleging breach of the Guaranty Agreements.  In response, the joint venturers filed a demand for arbitration against the lenders and later filed a motion in a North Carolina federal court to compel the lenders to arbitrate rather than litigate their disputes.  The North Carolina federal district court granted the motion to compel arbitration.

On appeal to the Fourth Circuit Court of Appeals, the lenders first argued that the individual joint venturers did not have a right to arbitration under the Guaranty Agreements.  The lenders contended that the Guaranty Agreement provision that afforded the individual joint ventures the "rights and remedies" of the joint venture pertained only to the lenders' right to bring a separate "suit" against the individual joint venturers under the Guaranty Agreement for each default by the joint venture.  The reference to "suit" in the Agreements, the lenders claimed, clearly indicated that arbitration was not intended as a means of resolving disputes under the Guaranty Agreements.  The lenders also claimed that arbitration is not a "right" or "remedy," which was incorporated by reference, but instead was a "process."  Finally, the lenders contended that the joint venturers' consent to be sued in federal court in New York required that all disputes between the parties be resolved in that court, not through arbitration.

The Fourth Circuit Court of Appeals disagreed and affirmed the lower court's decision to compel arbitration.  The court held that the lenders' contention that the joint venture did not substantially complete the project was in fact a dispute which was "arising out of or relating to" the construction contract.  As such, the dispute would have been arbitrable under the construction contract.  In response to the lenders' contention concerning separate "suits," the court concluded that the lenders' right to bring separate suits did not defeat arbitration but only clarified that the lenders need not bring all actions against the joint venturers at one time.  Next, the court held that under the construction contract, arbitration indeed was a "right," not just a "process."  Lastly, the court held that the joint venturers' consent to be sued in a New York federal court pertained only to disputes not "arising out of or relating to" the construction contract.  Accordingly, the court reasoned that this forum selection clause did not preclude arbitration of disputes arising out of the construction contract, such as the dispute at hand.

While courts are generally reluctant to compel a litigant who has not clearly agreed to arbitration to forego its day in court and arbitrate its disputes, the Fourth Circuit in Kvaerner had no such reservations.  Kvaerner illustrates that an arbitration agreement which is merely incorporated by reference will be enforced.  Kvaerner further illustrates the consequences of what can occur when parties to an agreement do not fully consider or account for contradictory provisions found in  agreements incorporated by reference.

 

SUBCONTRACTOR UNABLE TO COLLECT ON GEOGRAPHICALLY LIMITED PAYMENT BOND

While contractors on public projects are typically required to provide a payment bond, subcontractors performing work on public projects should not assume that the mere existence of a payment bond guarantees  a source of funding for their unpaid claims.  Instead, subcontractors must be aware of the precise terms and the penal sum of the bonds furnished on their projects.  In the recent case, United States v. Universal Surety of America, No. 99-2195, 2000 U.S. App. LEXIS 22262 (4th Cir. August 29, 2000), the Fourth Circuit limited a subcontractor's right to recovery from the prime contractor's payment bond surety to only $250,000.00 of $369,623.00 sought by the subcontractor.

In Universal Surety, the U.S. Army Corps of Engineers, in the aftermath of Hurricane Fran, awarded a contract to Waste Control Services as prime contractor for the removal of debris in eight counties in North Carolina.  Waste Control in turn subcontracted with D'Elegance Management Limited for debris removal in two of the eight counties.  Pursuant to the manner in which work was released by the government, Waste Control procured two separate payment bonds from Universal Surety of America.  The first payment bond was in the penal sum of $250,000.00 but did not place any geographic restrictions on the work covered by the bond.  The second payment bond was in the penal sum of $800,000.00 and expressly covered only that work performed for the government in Pender County.

Under the direction of Waste Control, the subcontractor performed its work in both Pender County and New Hanover County.  The subcontractor invoiced Waste Control a total of $2,752,684.00 for all work performed in both counties, $2,383,061.00 of which was paid.  After Waste Control failed to pay the remaining $369,623.00, the subcontractor filed suit against Waste Control's surety. 

Although the jury awarded the subcontractor its claim in full of $369,623.00, the verdict was subsequently overturned by the trial court and an appeal issued.  While the surety acknowledged $369,623.00 was the proper value of the subcontractor's unpaid work, the surety contended that the amount owed resulted from the subcontractor's work in New Hanover County and therefore was not covered by the larger $800,000.00 bond covering Pender County work.  

On appeal, the Fourth Circuit held that the subcontractor was entitled to recover only  $250,000.00, the full penal sum of the payment bond which was not geographically limited.  The court held the subcontractor could not recover on the $800,000.00 bond because of its inability to identify that the balance due was a result of unpaid work performed in Pender County.  Instead, the court accepted the surety's argument that using the first in, first out method of accounting, Waste Control had indeed fully paid the subcontractor for its work performed in Pender County (which the subcontractor indeed performed first).  Accordingly, the court held that the subcontractor had no claim on the $800,000.00 payment bond.  The subcontractor's situation was exacerbated by the fact that in making payments to the subcontractor, Waste Control did not specifically identify which work was covered by the payments issued.  Because only the $250,000.00 bond was available to satisfy claims on New Hanover County work, the court held the subcontractor could only recover up to the penal sum of the smaller bond.

The Universal Surety case raises three important points for subcontractors.  First, subcontractors should routinely obtain and review all applicable payment bonds for the project at the outset of construction.  Second, subcontractors must maintain detailed records of work performed.  Third, if a general contractor does not identify which work is covered by a payment, subcontractors should apply all payments received to their more problematic receivables first.  The subcontractor's apparent failure to take any of these measures resulted in its failure to collect the full value of its claim from the surety.

 

MARYLAND HIGH COURT INTERPRETS STATUTE OF LIMITATIONS' DISCOVERY RULE IN FAVOR OF BUILDERS

Under the "discovery rule" adopted by many states, the statute of limitations barring commencement of legal action begins to run when a claimant gains knowledge of a defect sufficient to put the claimant on "inquiry notice."  As of that date, a claimant is charged with knowledge of facts that could have been disclosed by a reasonably diligent investigation, the lack of such an investigation notwithstanding.

In Lumsden v. Design Tech Builders, Inc., 749 A.2d 796 (Md. 2000), twelve individuals entered into contracts for the purchase of homes in a housing development.  In early 1994, soon after the purchase of the homes, a snow removal service was hired to apply de-icing chemicals to remove snow.  In March 1994, several of the homeowners noticed that the surface of their concrete driveways were peeling and scaling.

Initially believing the problem to be the result of the de-icing chemicals, the homeowners complained to the builder who was still on-site performing construction.  However, the homeowners later began to suspect that the peeling and scaling occurred due to the builder's use of improper water-to-cement ratios during the pouring of the driveways.  The homeowners undertook further investigation and received several independent reports between March and October 1995.  These reports confirmed that the driveway problems were in fact the result of improper concrete pouring and curing.

When the builder refused to repair or replace the driveways, the homeowners filed twelve separate small claims actions in Maryland District Court.  After consolidating the twelve actions filed by the homeowners, the Maryland District Court ruled that the actions were barred by the statute of limitations.  The statute of limitations at issue, Md. Code Ann., Real Property § 10-204(d), provides for a two-year statute of limitations for breach of implied warranty.  The court ruled that the statute of limitations on the homeowners' claims began to run in March 1994 when the homeowners first discovered the problems with their driveways.  Accordingly, the court held the April 1996 filing of the complaints by the homeowners fell outside of the two-year statute of limitations period and was time-barred.

The homeowners appealed the decision all the way to the Maryland Court of Appeals.  The Maryland Court of Appeals once again affirmed the trial court, holding that the statute of limitations begins to run when a claimant gains knowledge sufficient to put it on "inquiry notice."  According to the court, from that date forward, "a claimant will be charged with knowledge of facts that would have been disclosed by a reasonably diligent investigation, regardless of whether the investigation has been conducted or was successful."  In this case, the statute of limitations began to run when the homeowners first noticed the problems with the driveways and not when they ascertained the true cause of the problems.

The Lumsden case represents a builder-friendly interpretation of Maryland's statute of limitations.  Accordingly, when faced with homeowner warranty claims which are more than two years old, builders, as a matter of course, should endeavor to ascertain when the homeowner first noticed the problem as this information may ultimately prove useful in resisting warranty claims.