November 2001 Newsletters

• MASSACHUSETTS' SURETY HIT WITH "A SUBSTANTIAL PUNITIVE JUDGMENT" FOR FAILING TO SETTLE SUBCONTRACTOR'S PAYMENT BOND CLAIM
  
  
• FAILURE TO COMPLY WITH CONTRACTUAL NOTICE AND DOCUMENTATION REQUIREMENTS PROVES FATAL TO ELECTRICAL CONTRACTOR'S $2 MILLION CLAIM FOR EXTRA WORK AND DELAY DAMAGES
  
  
• GENERAL CONTRACTOR FAILS TO OBTAIN INDEMNITY AND DEFENSE FROM SUBCONTRACTOR AND ITS INSURER
  
  
• SUIT BY SUBCONTRACTOR FOR ADDED COSTS OF CONSTRUCTION STAYED PENDING EXHAUSTION OF PRIME CONTRACT DISPUTE RESOLUTION PROCEDURES

Katz & Stone, L.L.P. Construction Newsletter
November/December 2001

 

MASSACHUSETTS' SURETY HIT WITH "A SUBSTANTIAL PUNITIVE JUDGMENT" FOR FAILING TO SETTLE SUBCONTRACTOR'S PAYMENT BOND CLAIM

Sureties play a vital role in public construction projects.  As a result, many states have enacted statutory guidelines regulating how insurance companies and sureties administer claims made on their policies or bonds.  Massachusetts is one such state that has enacted a legislative framework under which sureties can face substantial punitive damages if they do not fairly investigate and settle valid bond claims.  That framework includes Massachusetts' Little Miller Act (G.L.c. 149 § 29), its claims settlement statute (G.L.c. 176D), and its Consumer and Business Protection Act (G.L.c. 93A).

On September 6, 2001, in R.W. Granger & Sons, Inc. v. J&S Insulation, Inc.; United States Fidelity & Guaranty, SJC-08338 (Mass. 2001), the Massachusetts Supreme Judicial Court unanimously affirmed a trial court's substantial punitive judgment against a surety that had forced a claimant to litigate a valid bond claim.  In reaching its decision, the court made clear that in Massachusetts, sureties who force claimants to litigate bond claims where liability is reasonably clear will be harshly punished for such conduct.

In J&S Insulation, which arose out of construction work performed at Logan International Airport, the surety failed to effectuate settlement of a $203,000.00 payment bond claim even after the bond claimant, an insulation subcontractor, obtained a jury verdict against the project's general contractor.  After the verdict was issued, but before the subcontractor's request for statutory attorneys' fees was resolved, the subcontractor demanded the surety pay the undisputed portion of the judgment (principal and interest).  The surety, however, ignored the subcontractor's demand, raised what the court later described as "insincere defenses" and forced the subcontractor to litigate collection of the judgment.  The bond claim judgment, which was finally entered some ten months after the jury verdict, included the base claim for the subcontract balance,  ($203,867.31), interest ($86,835.02), and the attorneys' fees ($119,543.50) the subcontractor spent pursuing its claim.  The general contractor ultimately paid the entire bond judgment to the subcontractor.

As a result of the surety's dilatory conduct, the subcontractor asserted a claim against the surety for unfair and deceptive insurance practices.  The trial court agreed with the subcontractor and found that the surety's "cavalier" attitude toward its legal obligations "manifestly" violated the Massachusetts statues in question.  In rendering its decision on the unfair practices claim, the trial court found it particularly egregious that the surety could not explain why it waited more than four months to respond to the subcontractor's original demand, or why its only offer to settle the claim ($230,000.00 of $373,206.17) was "wholly inadequate" in light of the damages known to be due the subcontractor at the time of the offer.  Pursuant to the Consumer and Business Protection Act (the "Act"), the surety was found liable for twice the amount of the underlying bond judgment plus interest and the attorneys' fees the subcontractor spent to recover the punitive damages award.  Accordingly, the judgment against the surety arising out of the original $203,000.00 bond claim totaled $966,284.94 after the application of the Act.  The surety appealed.

On appeal, the surety argued that since the underlying bond judgment had been fully paid, it was not liable for any amount at all.  Alternatively, the surety argued that at the very least it was entitled to reduce the punitive damages judgment by $410,245.83 as a "credit" for the amount the subcontractor had already been paid directly by the general contractor.

The Massachusetts Supreme Judicial Court, however, rejected the surety's arguments and affirmed "in all respects" the trial court judgment.The court noted that the surety's "unreasonable settlement practices" clearly denied the subcontractor prompt recovery of the money it was owed, a direct violation of the law.  In addition, the court rejected the surety's argument that it was entitled to reduction of its punitive damages liability by a "credit" for the amount paid by the surety's principal.  In rejecting this argument, the court stated that the insurance practice statutes were expressly designed to deter unfair and deceptive acts or practices by imposing an "in terrorem" sanction on defendants who violate the statute.  The court stated that allowing the surety a credit against its punitive damage liability would undermine the plain language of, and legislative intent behind the applicable statutory framework.

The J&S decision represents an important victory for bond claimants in Massachusetts and provides significant incentive for sureties in that state to take an active role in assuring that proper claims are promptly and fairly resolved.  Bond claimants and sureties alike would be well-advised to familiarize themselves with the applicable claims settlement and insurance practices statutes and how these statutes may impact their rights and obligations.

Katz & Stone represented the bond claimant in the appeal before the Massachusetts Supreme Judicial Court.

 

 

FAILURE TO COMPLY WITH CONTRACTUAL NOTICE AND DOCUMENTATION REQUIREMENTS PROVES FATAL TO ELECTRICAL CONTRACTOR'S $2 MILLION CLAIM FOR EXTRA WORK AND DELAY DAMAGES

During construction, contractors often ignore the notice and claim submission requirements in their contracts in favor of a more informal, verbal resolution of such issues.  However, this approach can prove disastrous especially when the claims end-up in litigation.  Upon finding that a contractor's claim has not been supported with contractually-required notices or documentation, many courts will not hesitate in holding that the claim is barred.  The recent decision of a New York appellate court in the case of F. Garofalo Electric Company v. New York University illustrates not only the willingness of courts to bar claims which have not been submitted according to the contract's notice and submission requirements but also the reluctance of courts to enforce oral promises related to the claims procedure.  270 A.D.2d 76 (App. Div. 2000).

The case of Garofalo involved a contract between an electrical prime contractor and a university (the "owner") for the construction of a mixed-use building in Manhattan known as the Skirball Institute of Biomolecular Medicine and Residential Tower.  According to the electrical contractor, its work was delayed and extra work was required due to significant changes to the project and the failure of the owner's construction manager to coordinate the changed work performed by the electrical and other trade contractors.  As a result, the electrical contractor claimed entitlement to $2 million in additional compensation.

At trial, the owner unsuccessfully moved to dismiss the contractor's claims on the basis that the contractor had failed to provide contemporaneous written notice and documentation of its claims as required by its contract.  Although the contractor conceded that it did not strictly comply with the contract's requirements, the contractor argued that the owner had either abandoned, waived or modified the contract's  claim submission requirements by orally instructing it to perform the extra work without submitting the required notice of claim documents and by orally assuring the electrical contractor that its claims "would be taken care of at the end of the job."  The trial court held that the electrical contractor's argument raised questions of fact that should only be resolved at a trial of the action.

On appeal, the Appellate Division of the Supreme Court of New York reversed the trial court and dismissed the electrical contractor's claim in its entirety.  The appellate court held that the contract's notice and documentation requirements were conditions precedent to the electrical contractor's recovery; that is, the electrical contractor had no legal right to recover on the claims unless the contract's claim submission requirements had been satisfied.

The appellate court further held that the owner's oral assurances that the contractor could proceed with work without submitting the paperwork required by the contract did not relieve the electrical contractor of its responsibility to follow the notice and documentation requirements of its contract.  First, the court noted that the parties' contract required that all modifications be accomplished by a signed writing.  As such, any oral modification of the contract's requirements was unenforceable unless reduced to an executed writing.  Second, the court found that the electrical subcontractor's  disregard of the claim submission and documentation requirements based upon the oral instructions of the owner was unreasonable given the $2 million value of its claims.  Accordingly, the appellate court held that the contractor could not rely on the owner's oral assurance that the claim submission requirements of the contract need not be strictly observed.

As the Garofalo decision illustrates, contractors should operate under the presumption that the notice, claim submission and documentation provisions of their contracts will be strictly enforced by the courts, even when the party protected by such provisions has given oral assurances that such requirements need not be met.  While contractors may be somewhat reluctant to jeopardize good working relationships with owners and higher-tiered contractors by strictly following their contract's procedures, the discomfort involved with contract compliance far outweighs the risk of a total forfeiture of the claims at issue.

 

GENERAL CONTRACTOR FAILS TO OBTAIN INDEMNITY AND DEFENSE FROM SUBCONTRACTOR AND ITS INSURER

In the case of Jacobs Constructors, Inc. v. NPS Energy Services, Inc., 2001 U.S. App. LEXIS 19603 (3rd Cir. September 4, 2001), the court strictly interpreted a subcontract's indemnification provisions against a general contractor seeking indemnity and a defense from the subcontractor and its insurer.

In Jacobs, the owner of a refinery contracted with a general contractor to construct an addition to the refinery.  As part of the contract, the general contractor agreed to indemnify the owner for any liability and defense costs arising from the personal injury or death of subcontractor employees.  In turn, the general contractor required its mechanical subcontractor to indemnify the general contractor and to procure umbrella and general liability insurance that named the general contractor and owner as additional insureds.

When a fire at the refinery killed several of the mechanical subcontractor's employees, the estates of the deceased employees filed suit against the owner.  The owner in turn made demand upon the general contractor and subcontractor for indemnification.  The subcontractor and its insurer ultimately settled with the owner for $5 million and the owner expressly reserved its right to recover additional amounts for indemnity from the general contractor.

In response to the owner's suit for indemnity, the general contractor filed a declaratory judgment action against the subcontractor seeking a declaration that it was entitled to a defense and indemnification from its subcontractor.  The general contractor also filed a similar action against the subcontractor's insurer.

On motions for summary judgment, the trial court ruled that the subcontractor owed a duty to defend the general contractor, that the subcontractor satisfactorily named the general contractor and owner as additional insureds, and that the subcontractor's insurer did not owe the  general contractor a defense because the general contractor was an "additional" rather than a named insured.  The parties filed cross appeals.

The Third Circuit Court of Appeals reversed the trial court's ruling regarding the subcontractor's duty to defend.  The court noted that although the claims against the owner were personal injury tort claims, the owner's claim against the general contractor was in fact a contract claim.  Applying Pennsylvania law, the court ruled that because the indemnification clause in the subcontract did not expressly include claims for contractual indemnity, the clause was to be construed against the general contractor.  Applied to the context of the duty to defend, the court held that the subcontractor was only liable for tort claims brought directly against the contractor and not for contract claims brought by the owner through a contractually-imposed obligation.

Finally, the appeals court affirmed the trial court's ruling that the subcontractor's insurer did not owe the contractor a duty to defend or indemnify.  The insurance policy provided coverage for liability "assumed by the Insured under an Insured Contract . . . ."  However, the insurance policy's definition of "insured" only provided coverage to agreements entered into by "named insureds."  Thus, the court concluded the policy did not cover liability that an "additional insured," such as the general contractor, assumed pursuant to an indemnity agreement.

The Jacobs case is a further illustration of the rule that most courts will strictly construe indemnity provisions against the party seeking indemnification.  Accordingly, the indemnitee cannot be too careful in drafting the indemnity and insurance provisions of its contracts.  The general contractor's failure to unequivocally and expressly provide that its subcontractor provide indemnification against, and insurance coverage for, contractual indemnity claims brought against it by the owner, ultimately proved fatal to its attempt to avoid liability for the injuries suffered by its subcontractor's employees.

 

 

SUIT BY SUBCONTRACTOR FOR ADDED COSTS OF CONSTRUCTION STAYED PENDING EXHAUSTION OF PRIME CONTRACT DISPUTE RESOLUTION PROCEDURES

Construction subcontracts often incorporate dispute resolution procedures established in the prime contract.  Such procedures usually require that the subcontractor submit its claims, through the general contractor or construction manager, to an independent person or panel for review.  As a subcontractor learned in BAE Automated Systems, Inc. v. Morse Diesel Int'l, Inc., 2001 U.S. Dist. LEXIS 6682 (S.D.N.Y. May 22, 2001), failure to first comply with such procedures may prevent the bringing of those claims in arbitration or litigation.

In BAE, the contract between the project owner and construction manager established a disputes procedure that required all project-related claims arising during design and construction to be submitted to a Disputes Review Board ("DRB") for non-binding adjudication.  The construction manager's contract with the subcontractor incorporated the procedure and obligated the subcontractor to exhaust it before commencing any other action on claims arising out of its work.  Moreover, the subcontract provided that, upon the subcontractor's written request, the construction manager would pass on all of the subcontractor's claims submitted pursuant to the procedure.  After substantial completion of its work, the subcontractor submitted to the construction manager a claim for increased costs due to alleged mismanagement by the construction manager.  Nearly a year later, the construction manager advised that the claim should be submitted to the DRB, but the subcontractor disagreed and brought suit on the claim.  The construction manager then requested that the suit be stayed unless and until the subcontractor complied with the disputes procedure.

The federal district court granted the stay, concluding that the subcontract unambiguously incorporated by reference the prime contract disputes procedure and required the subcontractor to exhaust that procedure for all of its work-related claims prior to filing suit.  Despite the fact that the subcontractor's claim was based on alleged misdeeds by the construction manager, the court found nothing in the subcontract limiting use of the disputes procedure to claims attributable to the owner's conduct or exempting claims against the very construction manager that had to pass them on to the DRB.  Moreover, contrary to the subcontractor's contention that, because its claim was submitted after substantial completion, the claim did not "arise during design and construction" and was thus not subject to the disputes procedure, the court held that, although the claim was raised after the subcontractor's work was finished,  the claim did arise from the work and thus had to be submitted to the DRB.  Finally, the court found that the construction manager had not waived its right to invoke the disputes procedure by failing to pass the subcontractor's claim on to the DRB because, even though it had submitted its claim to the construction manager nearly a year earlier, the subcontractor never requested in writing that the claim be passed on.

For any contractor, compliance with the terms of its contract is a must.  If the contract incorporates terms of other contracts, compliance with those incorporated terms is just as important.  As demonstrated in BAE, a contractor's failure to comply with such terms can mean months of delay in the resolution of claims.