Cases of the Month
Significant Cases and Decisions Impacting the Construction Industry
By: Ira Genberg and Ryan Stinnett
1. Effect of Construction Moratorium on Government’s Obligations under Requirements Contract, Hermino Pagan Padilla a/k/a Pagan Constr., Inc. v. United States, 2003 WL 22857370 (Fed. Cl. 2003).
* What the Court Considered: A contractor entered a requirements contract with the Army for the installation, repair, and maintenance of fences on an Army base. After contract modifications, the contract period was set to run from the date of award until December 31, 2000. On October 30, 2000, Congress imposed a moratorium on new construction at the Army base, which had the effect of halting performance under the contract. In March 2002, 14 months after its last payment under the contract, the contractor filed a claim alleging that the Army breached its contract by awarding the remaining installation and repair work to a third party after the moratorium was lifted.
* What the Court Said: The Army did not breach its contract when it stopped ordering services from the contractor as a result of the Congressionally-mandated construction freeze.
* What the Opinion Means: When a government requirements contract calls for services prohibited by a Congressional moratorium, the government has no requirements during the moratorium. While the Army’s actual requirements might have been less than the contractor or the Army anticipated, the Army was not required to do anything more than it did under these circumstances. Accordingly, the Army did not breach its contract with the contractor by awarding work to a third party after the contract period had terminated. Additionally, the moratorium did not automatically extend the performance period under the contract for a period of time equal to the length of the moratorium. Therefore, according to its unambiguous terms, the contract expired on December 31, 2000, and the Army was free thereafter to order the same services as set out in the contract from other parties.
2. Government’s Contractual Obligations Under an Indefinite Delivery/Indefinite Quantity Contract, Abatement Contracting Corp. v. United States, 2003 U.S. Claims LEXIS 356 (Fed. Cl. 2003).
* What the Court Considered: A government contractor executed a requirements contract for asbestos removal and insulation installation. The contract was amended to an indefinite delivery/indefinite quantity (“ID/IQ”) contract. The ID/IQ contract expressly stated that it was not a fixed-price contract, that there were no guarantees as to the amount of work, and that delivery orders would determine the amount of work. After the government had ordered the minimum amount of work required by the ID/IQ contract, a dispute arose when the government refused to pay a certain price per square foot for a subline item of asbestos encapsulation work and stated that it would bring in another contractor to do the work at a different price. The contractor claimed that the government breached the contract because it was entitled under its contract to receive the requested price per square foot for the work.
* What the Court Said: The government did not breach the ID/IQ contract because the it ordered more than the contract’s minimum quantity of $50,000.00 in supplies and services from the contractor.
* What the Opinion Means: Under an ID/IQ contract, the government is obligated to purchase only a stated minimum quantity of supplies or services from a contractor, with deliveries to be scheduled as ordered by the government. Once the government orders the contract minimum (as long as such minimum is more than a nominal amount), the government’s obligations under the ID/IQ contract are extinguished and the contractor is barred from asserting a claim for breach of contract. From that point forward, the government is free to purchase additional supplies or services from any other source it chooses.
3. Recovery Sought by Government Contractor of Criminal Investigation Defense Costs, Brownlee v. Dyncorp, 349 F.3d 1343 (Fed. Cir. 2003).
* What the Court Considered: A government contractor and its employees were investigated by the Army for allegations of criminal activity relating to the contractor’s performance of the contract. In accordance with Delaware law (the law of the contractor’s state of incorporation) and its bylaws, the contractor paid the costs of its defense and the defense of its employees. The contractor’s branch manager pled guilty to a charge of unauthorized access to a government computer. However, no criminal or civil actions were filed against the contractor as a result of the investigation. The contractor then submitted a claim to the government seeking reimbursement under its contract of its costs, other than the legal fees of the attorneys that defended the convicted employee, that were incurred in connection with the criminal investigation.
* What the Court Said: The contractor was not entitled under its contract to reimbursement of any of its costs of defending against the criminal investigation.
* What the Opinion Means: Federal Acquisition Regulation 31.205-47(b), which was incorporated into the government contract at issue, disallows reimbursement for “[c]osts incurred in connection with any [criminal] proceeding brought by [the federal] government for violation of, or a failure to comply with, law or regulation by the contractor (including its agents or employees)” if a conviction results from such proceeding. Accordingly, a government contractor may not recover from the government any costs incurred in the unsuccessful defense of criminal proceedings where an employee of the contractor is convicted, even if the contractor itself is not charged with criminal activity.
4. Constitutionality of Disadvantaged Business Enterprise Program, Sherbrooke Turf, Inc. v. Minnesota Dep’t. of Transp., 345 F.3d. 964 (8th Cir. 2003).
* What the Court Considered: Two non-minority contractors challenged the federal government’s Disadvantaged Business Enterprise (“DBE”) Program, created as part of the Transportation Equity Act for the 21st Century, as violative of the Fifth Amendment’s equal protection clause. The DBE Program sets as a goal the awarding of ten percent of all federal highway construction funds to small businesses owned by “socially and economically disadvantaged individuals.” The non-minority contractors had submitted lower bids on federally assisted highway projects; however, such contracts were awarded to others who qualified for the DBE Program.
* What the Court Said: The DBE Program for federally funded highway contractors satisfies the strict scrutiny analysis required under the Fifth Amendment’s equal protection clause.
* What the Opinion Means: The U.S. Department of Transportation may continue to seek to award ten percent of all federal highway construction funds to small businesses that are owned by “socially and economically disadvantaged individuals.” For purposes of the DBE Program, socially disadvantaged individuals are “those who have been subjected to racial or ethnic prejudice or cultural bias because of their identity as a member of a group without regard to their individual qualities.” Similarly, economically disadvantaged individuals are “those socially disadvantaged individuals whose ability to compete in the free enterprise system has been impaired due to diminished capital and credit opportunities as compared to others in the same business area who are not socially disadvantaged.” In determining whether a contractor qualifies for the DBE Program, there is a rebuttable presumption that women and members of most racial minority groups are socially and economically disadvantaged. Also, an individual whose personal net worth exceeds $750,000.00 is not economically disadvantaged and small businesses do not qualify for the DBE Program if their earnings exceed $16.6 million per year in the previous three fiscal years.
5. “Standby” as an Element of Recovery of Eichleay Damages, P.J. Dick Inc. v. Principi, 324 F.3d 1364 (Fed. Cir. 2003).
* What the Court Considered: A government contractor agreed to construct an addition to a medical center, with work to be completed by January 12, 1998. During the work, the government issued over 400 orders that changed the contract and delayed various aspects of the project. The changes increased the contract price by more than five percent and caused the government to grant 107 days of additional contract performance time. The contractor completed the project 260 days after the original contract completion date and 153 days after the revised date. The contractor sought recovery of unabsorbed home office overhead (Eichleay damages).
* What the Court Said: The contractor was not entitled to recover unabsorbed home office overhead because it failed to prove that it was placed on standby, one of the necessary elements of Eichleay damages.
* What the Opinion Means: The P.J. Dick court clarified that a government contractor must show the following elements to prove that it was put on standby: (1) the government-caused delay was not only substantial, but was of an indefinite duration; (2) during the delay, the contractor was required to be ready to resume work on the contract, immediately and at full speed; and (3) there was an effective suspension of much, if not all, of the work on the contract. Therefore, if a contractor is able to continue work on parts of the contract that are unaffected by the government-caused delay, it is not on standby. In this case, because the contractor’s work on much of the contract had not been suspended, it was unable to prove entitlement to home office overhead under the Eichleay formula. (However, it should be noted that the contractor ultimately did recover some home office overhead through a stipulation with the government under the contract’s Suspension of Work clause.)
6. Surety’s Duty of Good Faith in Completing Work Under a Performance Bond, Travelers Cas. & Sur. Co. of Am., Inc. v. Jadum Constr., Inc., 2003 U.S. Dist. LEXIS 11861 (D. Mass. 2003).
* What the Court Considered: A contractor voluntarily terminated its obligation to construct a hotel under an $8 million contract. The contractor’s surety assumed responsibility for the project under its performance bond and spent $9,141,059 to complete construction of the hotel. The surety then sought to recover $6,860,021 from the contractor, which was the amount spent by the surety less the sum of the amount remaining on the contract when the contractor left the project and the value of the owner’s change orders. The contractor argued that it was not responsible to repay any costs beyond the original $8 million contract price, because such excess spending by the surety was evidence of the surety’s bad faith.
* What the Court Said: Because the contractor could not identify specific acts of bad faith by the surety, the contractor was liable to reimburse the surety for the entire sum of $6,860,021.
* What the Opinion Means: Under Massachusetts law, the test for bad faith by a surety is whether the surety acted with “a dishonest purpose, conscious doing of wrong, or breach of duty through motive of self-interest or ill will.” A showing of “bad judgment, negligence or insufficient zeal” by a surety is insufficient to satisfy this test. Although a surety’s excessive payment may have been negligent, or even reckless, the surety’s overpayment alone will not provide sufficient evidence of bad faith to release the contractor from its obligations under an indemnification agreement, even when the surety seeks recovery of more that the amount of the contractor’s original contract.
7. Waiver of Right to Assert Claim Against Bonding Company Under Miller Act, Coastal Masonry, Inc. v. Reliance Ins. Co., 297 B.R. 34 (E.D. Va. 2003).
* What the Court Considered: A bankruptcy trustee sought to recover alleged preference payments made by a contractor within the ninety days before the contractor was put into involuntary Chapter 7 bankruptcy. The defendants were subcontractors and suppliers on several projects and the contractor’s surety. One subcontractor filed a cross-claim against the surety to recover the $50,000 that it paid to the trustee to settle the preference claim against it. The surety argued that the subcontractor had waived any Miller Act claims against the surety in its subcontracts. The subcontractor argued that the surety could not enforce the waiver because the surety was not a party to, or intended beneficiary of, the subcontract.
* What the Court Said: The surety could enforce the waiver against the subcontractor.
* What the Opinion Means: Where a subcontract expressly provides for a waiver of a subcontractor’s right to assert a claim against the contractor’s bonding company pursuant to the Miller Act, the contractor’s surety is an intended beneficiary of such contract and may enforce the waiver against the subcontractor. However, for such a waiver to be valid and enforceable, it must be “in writing, signed by the person whose right is waived, and executed after such person has first furnished labor or material for use in the performance of the contract.”
8. Supplier’s Obligation to File Notice of Furnishing, Linworth Lumber Co. v. Z.L.H. Ltd., 2003 Ohio App. LEXIS 3713 (Ohio Ct. App. 2003).
* What the Court Considered: A supplier on a construction project filed a lien, which was then substituted by a bond, against the owner’s real estate when the contractor failed to pay the supplier. However, the supplier had failed to file a notice of furnishing for the project, as required by an Ohio statute. The supplier argued that it was not required to file a notice of furnishing because the owner did not substantially comply with the notice of commencement statute. For example, the owner’s notice of commencement failed to contain several items required by the statute and named an incorrect party as the original contractor.
* What the Court Said: The supplier was not excused from filing a notice of furnishing; therefore, it could not recover against the owner on the bond.
* What the Opinion Means: In this case, the owner’s original notice of commencement, although not in strict compliance with the statute, was sufficient to put the supplier on notice of the items required for a notice of furnishing, specifically the owner’s name and the address of the property. Any later change or amendment to the notice of commencement, such as to correct the name of the original contractor, does not affect the effective date or validity of the notice of commencement or the supplier’s statutory obligation to file a notice of furnishing.
9. Duress in Signing Release as Basis for Recovering Retainage under Subcontract, Cox & Floyd Grading, Inc. v. Kajima Constr. Svcs, Inc., 2003 S.C. App. LEXIS 184 (S.C. Ct. App. 2003).
* What the Court Considered: A subcontract expressly required arbitration of all disputes between the contractor and subcontractor. After arbitration of a dispute, the subcontractor’s president signed an “Affidavit and Unconditional Waiver and Release Upon Final Payment” (the “Release”) confirming “full retainage received.” Eight months later, following payment of the arbitration award in exchange for a complete and final release of all claims under the parties’ subcontract, the subcontractor filed suit to recover retainage pursuant to the subcontract. The subcontractor claimed that it had signed the Release under duress due to financial despair arising from the contractor’s withholding of payments.
* What the Court Said: The subcontractor failed to present sufficient evidence of duress to allow it to seek payment of retainage outside the context of the Release.
* What the Opinion Means: Under South Carolina law, “[d]uress is a condition of mind produced by improper external pressure or influence that practically destroys the free agency of a party and causes him to do an act or form a contract not of his own volition.” In this case, the alleged “duress” arose from a written request by the contractor for the subcontractor to execute standard release documents in exchange for payment of the arbitration award. This exchange of settlement documents, through counsel, was insufficient to support the subcontractor’s “belated attempt to resurrect the retainage issue and thwart the arbitration process and final award.”
10. Recovery under CGL Policy of Costs to Repair Defective Work, NAS Sur. Group v. Precision Wood Prods., 271 F.Supp.2d 776 (M.D. N.C. 2003).
* What the Court Considered: A supplier’s insurance company denied coverage under its comprehensive general liability (“CGL”) policy for the costs of repairing the supplier’s defective cabinetry and millwork at a hospital project. The CGL policy applied to “property damage” caused by an “occurrence.” An “occurrence” was defined as “an accident, including continuous or repeated exposure to substantially the same general harmful conditions.”
* What the Court Said: The supplier’s defective workmanship was not an “accident” that constituted an “occurrence” that would trigger coverage under the supplier’s CGL policy.
* What the Opinion Means: As a general principle of South Carolina law (and as exemplified by the CGL policy), a supplier’s defective workmanship will not constitute an “accident” under a CGL policy because defective workmanship is “a business risk ‘reasonably anticipated’ by” the supplier. A supplier’s failure to conform its work product to contract specifications is properly remedied by performance bonds rather than CGL policies. Also, under the facts of this case, the costs incurred to repair drywall, repaint walls, and reinstall sinks, wiring, and plumbing arising from the supplier’s defective workmanship were not covered by the CGL policy because they were also foreseeable consequences of the replacement of defective work.
Ira Genberg is a Senior Partner at the Smith, Gambrell & Russell, LLP law firm in Atlanta, Georgia, and also General Counsel for Associated Owners & Developers (AOD), McLean, Virginia. Ryan Stinnett is an Associate at Smith, Gambrell, & Russell, LLP. For more information or if you have any questions, contact us at: firstname.lastname@example.org.