Newsletters

• 486 Indemnification: What Constitutes Surety Bad Faith?
• 487 The Legal Implications of Design-Build
• 488 North Carolina: Mediation on Public Projects
• 489 Florida License Loans – Risky Business
• 490 Challenges to Arbitration Enforcement
• 491 “Float Time” - Defining the Term
• 492 South Carolina: Standard of Care for Highway Contractors
• 493 Demands on Sureties

486 Indemnification: What Constitutes Surety Bad Faith?

Overview

The Connecticut Supreme Court recently addressed a surety’s right to collect under its indemnification agreement in the face of allegations by the indemnitor that the surety acted in bad faith. In doing so, the court surveyed the law from other jurisdictions and the treatises on this subject, thereby providing a valuable synopsis of the law concerning the covenant of good faith and fair dealing as it applies to sureties.

Basic Legal Principles

In PSE Consulting, Inc. v. Frank Mercede & Sons, Inc., 838 A.2d 135 (Conn. 2004), the court was asked to reverse a judgment entered in favor of the indemnitors and against the surety, which had sought indemnification for the $700,000 paid to a subcontractor in satisfaction of a payment bond claim. The jury based its verdict in favor of the indemnitors on a finding that the surety had breached the implied covenant of good faith and fair dealing when it paid the payment bond claim.

On appeal, the surety argued that the trial court’s refusal to enter a directed verdict in its favor was error. The court acknowledged that indemnity agreements typically guarantee the surety wide discretion in settling claims made upon a payment bond. However, the court also noted that “discretion was not unfettered,” because “the surety is entitled to indemnification only for payments that were made in good faith.”

The court’s decision, which contains a lengthy discussion of the legal principles, concludes that, in order to prove a breach of the implied covenant of good faith and fair dealing, the indemnitor must “establish something more than mere negligence,” but something less than fraud. The court held that the indemnitor must show an “improper motive” or “dishonest purpose” on the part of the surety. The court held that such a standard would provide a proper balance between the surety’s discretion to settle claims and the indemnitor’s right to be protected from “serious and willful transgressions.”

Factual Background

Measuring the evidence against that standard, the court concluded that the jury could have found that the surety’s investigation of the subcontractor’s claim was “superficial” and in violation of the requirements in its own bond. The question before the court was whether an improper investigation, by itself, constituted bad faith. The court concluded that the failure to investigate, standing alone and not accompanied by other evidence of an improper motive, is not enough to constitute bad faith.

The court further concluded that the jury could also have found that the surety settled the payment bond claim to protect its own self interest (i.e., to avoid an investigation by the insurance commissioner, which had been sent some of the subcontractor’s correspondence complaining about the surety’s handling of the claim) and/or to obtain a release of the subcontractor’s claim that the surety had acted in bad faith and had violated Connecticut’s Unfair Trade Practices Act. The court pointed out that a self-interested settlement “unblemished by any other evidence of bad faith” would not constitute a per se violation of the implied covenant of good faith and fair dealing. However, the settlement in combination with the other circumstances in the case (including the principal’s objection to or ignorance of payments by the surety to the subcontractor and the surety’s initial support of the principal’s rejection of the claims), could provide a basis for a jury to find that a self-interested settlement was made for an improper motive. The court also recognized that the unique nature of the tripartite relationship among surety, principal, and claimant often confronts the surety with a dilemma of bad faith claims from the claimant for not paying, or bad faith claims from the principal and indemnitors for paying. The court felt that the surety did not resolve that dilemma in a proper manner in this case.

Comment and Practical Implications

While this decision may not break any significant new ground on the law of suretyship, it does put a much sharper point on the application of the implied covenant of good faith and fair dealing in the context of indemnity agreements. On the one hand, the court recognized the fact that an inadequate investigation by a surety in and of itself does not establish bad faith. In addition, the court cautioned that an improper motive still must be established. In finding that the jury could have found that the surety settled solely out of self-interest, the court seemed to rely heavily on the following factors: First, the surety failed to conduct a reasonable investigation of the claim. While the bond obligated it to pay undisputed amounts within 45 days of receipt of the claim, or to explain the basis for rejecting the claim, the surety did neither. Secondly, the evidence also showed that the surety never reviewed the project records and at most only engaged in a superficial review of the claim.

In summary, the majority of states do recognize a duty of good faith by a surety. Although the weight of authority seems to be on the side of recognizing a duty of good faith, there is no general consensus as to what the duty requires. As the court observed in the Mercede case, courts that have recognized a duty of good faith in the suretyship context have typically done so on one of two bases: either because they recognize the existence of such a duty in all contracts, or because they recognize the existence of such a duty in the insurance context to which they analogize surety contracts.

Some courts hold that the surety must at least investigate to determine whether a principal’s asserted defenses are viable. Other courts have opted for a more general approach, requiring the surety to give the principal’s interest equal weight with the surety’s. Some courts have adopted a negligence standard to determine whether the surety remains entitled to indemnification. Finally, some courts have denied indemnification only where the surety has acted with an improper motive, such as in the Mercede case. In short, there is no agreement about what the duty of good faith requires in the suretyship context, and particular care must be exercised to investigate the controlling law governing your jurisdiction and situation.

J. Louise Dietzen
404/582-8126
jldietzen@smithcurrie.com

487 The Legal Implications of Design-Build

Design-build is quickly becoming the project delivery system of choice for many projects. Thus, it is important for all participants in the construction process to better understand design-build and how it will impact their industry and their individual businesses in the years ahead. That understanding should include a basic understanding of the legal implications of design-build and how the design-build project delivery system alters the legal paradigm under which the parties operate.

Contract Formation Issues

D-B Team Structure: A design-builder may be a company possessing both design and construction capabilities in-house; it may be a general contractor which, in turn, hires an architect/engineer to design the project, operating essentially as a subcontractor to the design-builder; it may, in some states, be an architect/engineer, which, in turn, hires a contractor to construct its design; or it may be a joint venture comprised of one or more design firms plus one or more construction firms. In some states, such as North Carolina, current laws require that the entity holding the contract with the owner be a licensed general contractor. This effectively precludes “architect-led” design-build construction in those states, requiring “contractor-led” design-build instead. This illustrates why it is important that parties considering design-build projects first consider whether the state in which the project will be constructed has any laws which might impose constraints on how the project team is to be structured contractually.

Selection of the Contractor: In the private sector, selection of the design-build contractor is usually within the owner’s discretion. In the public sector, as design-build became more popular, competitive bidding laws in many states were rewritten to enable public owners to utilize the project delivery system. Almost by definition, when multiple bidders (or offerors) are competing for award of a design-build contract, they are submitting prices based upon somewhat different projects, i.e., each offeror’s unique design. Accordingly, design-build does not lend itself to selecting a contractor based upon the traditional competitive bidding process where price is the only determinant, because an “apples to apples” comparison is not possible. Even in the public sector, the selection of a design-builder must be based, in part, on subjective factors. In many states, new public procurement legislation had to be enacted in order to allow public owners this flexibility in the contractor selection process.

Although the use of the design-build project delivery system has increased exponentially over the past two decades, like many “new ideas”, design-build is actually the rebirth of an old one. Modern day design-builders are closely akin to the “Master Builders” of yesteryear who built the Pyramids of Egypt, the Great Wall of China, and India’s Taj Mahal. Obviously, construction techniques have changed since those ancient projects were constructed, and most modern-day construction projects do not take scores of years to construct. Yet, the underlying philosophy that it is better to simplify the contract structure, by allowing the owner to look to a single point of responsibility and accountability for both design and construction, is as sound today as it was then. Moreover, advocates of design-build would argue that the inherent benefits of design-build are even more relevant today than they were in the days of old. The modern-day construction process involves complex regulatory, environmental, societal, economic, and other challenges and constraints that the ancient Master Builders could not have imagined. Out of this greater complexity comes an even greater need to simplify the process by unifying responsibilities.

Ramifications of Use of Design-Build

Regardless of the method of project delivery, every project involves the consideration of risks. In order to assess and manage the risks inherent in any construction project, the parties should make sure they know, and agree upon, who is responsible, and to what extent, for each of the following:

1. Suitability of the design;
2. Design changes;
3. Coordination of contractors;
4. Control of the schedule;
5. Control of the budget;
6. Unforeseen subsurface conditions;
7. Changes in market conditions;
8. Any loss of productivity;
9. Unanticipated schedule impacts; and
10. The unexpected.

The allocation of these risks may vary depending upon the project delivery method. Owners, contractors, and designers who are new to design-build are sometimes surprised by the answer to some of these questions. Contractors are not accustomed to being accountable to the owner for the suitability of the project design, as they are under design-build. This is the complete opposite of the Spearin doctrine: the implied warranty that the plans and specifications are accurate, which usually applies when the owner furnishes the design to the contractor. Contractors also may assume far greater risks with respect to unanticipated subsurface site conditions under design-build construction than with other project delivery systems.

Making Design-Build Work

As with any construction project, the biggest key to a successful design-build project is to select the right project team. While the selection of the best project delivery system for a particular project is important, the selection of the right people to fill in the boxes on the organizational chart is even more so. This may be even more critical under the design-build project delivery approach than under other contracting structures.

Philip E. Beck
404/582-8028
pebeck@smithcurrie.com

488 North Carolina: Mediation on Public Projects

Background

For many years the construction industry has successfully used alternative dispute resolution procedures such as arbitration and mediation to resolve construction claims. Mediation has become increasingly popular as a cost effective method of resolving construction disputes. Recently, the North Carolina General Assembly and the North Carolina State Construction Office (“SCO”) have embraced mediation as a procedure for resolving disputes involving state and local government building projects in North Carolina.

In 2002, the North Carolina General Assembly substantially amended the primary statutes covering public building construction in North Carolina. The amendment added a provision requiring any public entity to use alternative methods of dispute resolution adopted by the SCO or to use a comparable process, specifically including non-binding mediation, “. . . for any issues arising out of the contract or construction process.” N. C. Gen. Stat. § 143-128(f1). Temporary rules issued by the SCO for mediations to resolve disputes involving public building projects took effect in July, 2002.

Overview of Permanent Rules

In August, 2004, the temporary regulations adopted by the SCO for mediated settlement conferences became permanent. Under the SCO rules, “any party to a public construction contract” and to a dispute “arising out of the construction process,” which involves at least $15,000 may request mediation of the dispute by submitting a request to the SCO or local government owner. N.C. Admin. Code tit. 1, T1-C30-S30H.0102. Non-binding mediated settlement conferences arranged through the SCO are now an alternative to more formal procedures for resolving claims arising under state or local government building construction contracts in North Carolina.

The SCO regulations provide for “all parties” to the construction claim or dispute to take part in the mediation and thus provide a means for multi-party mediations involving contractors, owners, subcontractors, suppliers, architects, and engineers. N.C. Admin. Code tit. 1, T1-C30-S30H.401. In this regard, the SCO regulations go well beyond the provisions of construction contract documents by extending mediation to include others besides the parties to the contract.

The SCO's mediation procedure is straightforward. Before submitting a mediation request, the party requesting mediation must first have submitted the claim to the other party to the contract. A claim “becomes ripe for mediation” only if it is not resolved directly by the parties. N.C. Admin. Code tit. 1, T1-C30-S30H.0102(b).

The parties may select an appropriately certified mediator, and then file a “Notice of Selection of Mediator” within 10 days with the SCO. If the parties are unable to agree upon a mediator, the SCO or other public owner appoints one. N.C. Admin. Code tit. 1, T1-C30-S30H.0201. The parties then are to enter a written agreement as to the arrangements for the mediation – the location, time, and scope -- and the mediation is to be completed within 60 days after execution of the mediation agreement. N.C. Admin. Code tit. 1, T1-C30-S30H.0202. As with all mediations, the process is not binding and statements during the course of the conference are not admissible in evidence should the dispute proceed to trial or arbitration. If an agreement to settle a claim is reached at the mediation, the terms are to be put in writing and signed by all the parties. N.C. Admin. Code tit. 1, T1-C30-S30H.0402.

Comment

Whether North Carolina contractors, subcontractors, architects, and owners will take advantage of the SCO's new rules for mediated settlement conferences to resolve disputes involving local government building projects remains to be seen. However, making the mediation process available for use in resolving claims arising from state and local building projects provides an alternative to the time consuming and expensive formal dispute resolution process set out by statutory and contract provisions. For that reason alone, the new mediation procedure is worth considering anytime a claim arises on a state or local government building project in North Carolina.

Rolly L. Chambers
704/334-3459
rlchambers@smithcurrie.com

489 Florida License Loans – Risky Business

Are you a certified or registered construction contractor in Florida? If so, be mindful that it is unlawful for you to knowingly allow your license to be used by a person or business organization that is not a licensed contractor, i.e., an unlicensed contractor. A licensed contractor in Florida who “loans” its license to an unlicensed contractor to engage in contracting or act as a contractor is subject to substantial civil and criminal penalties. In the recent case of RTM General Contractors, Inc. v. G/W Riverwalk, LLC, 2004 WL 1836223 (Fla. App. 2 Dist.) a Florida appellate court affirmed a quarter million dollar judgment in favor of an owner on its counterclaim against a contractor that it knowingly allowed its license to be used by an unlicensed contractor.

Statutory Background

Section 489.127, Florida Statutes, prohibits certain activities relating to the furnishing of contracting services. Activities such as falsely holding oneself out as a licensed contractor, presenting the license of another as one’s own, or using or attempting to use a license that has been suspended or revoked, are prohibited. Section 489.127 also provides penalties for engaging in such activities.

With respect to a contractor loaning its license, Section 489.127(4)(a), Florida Statutes, prohibits a contractor from entering into an oral or written agreement whereby its license number is used by an unlicensed contractor. Section 489.127(4)(c), generally prohibits a contractor from applying for or obtaining a building permit for construction work unless the contractor has entered into a contract to perform the work specified in the application or permit. Section 489.127(4)(b), the subsection at issue in RTM, prohibits a contractor from knowingly allowing a license to be used by an unlicensed contractor.

Factual Background

RTM and Riverwalk entered into three contracts for RTM to renovate Riverwalk’s property. RTM did not perform any of the construction work on the Riverwalk project. Instead, RTM knowingly allowed an unlicensed contractor, DeVore and Associates and its principal, to use RTM’s license to perform all of the work on the project. The principal of DeVore and Associates was not an employee of RTM. If he had been an employee of RTM, he would have been exempt from the licensure requirement if he were acting within the scope of RTM’s license and with RTM’s knowledge and permission.

RTM filed a claim of lien on Riverwalk’s property in the amount of $245,243. RTM subsequently filed a lawsuit to foreclose its claim of lien. In its counterclaim, Riverwalk alleged that RTM breached the contracts and that RTM had filed a fraudulent lien.

Contractor Claims Denied

The trial court found that the contract were null, void and unenforceable on the ground that RTM knowingly allowed an unlicensed contractor to use RTM’s contractor’s license in violation of Section 489.127(4)(b), Florida Statutes. The trial court also found that RTM’s claim of lien was unenforceable, willfully included amounts not owed to RTM, and was fraudulent.

Under Section 713.31(2)(c), Florida Statutes, a lienor such as RTM that files a fraudulent lien shall be liable to the owner (Riverwalk) for damages, costs, attorneys’ fees, the amount of any premium for a bond given to obtain the discharge of the lien or interest on any money deposited for the purpose of discharging the lien, and punitive damages in an amount not exceeding the difference between the amount claimed by the lienor to be due or to become due and the amount actually due or to become due.

RTM’s lien was found to be fraudulent. Hence, no amount was due Riverwalk pursuant to Section 713.31(2)(b). The difference between the amount claimed by RTM to be due, $245,243, and the amount actually due, $0.00, represented RTM’s liability to the owner. Therefore, the trial court entered judgment in favor of the owner in an amount equal to RTM’s claim of lien, $245,243.

The Second District Court of Appeals affirmed the trial court’s judgment. The appellate court also rejected RTM’s argument that the subsequent licensure of DeVore and Associates as a general contractor during the course of litigation cured RTM’s initial violation of Section 489.127(4)(b).

Comment

Allowing an unlicensed contractor to use another’s license to perform contracting services is simply not worth it. In addition to a loss of lien rights, the licensed contractor may be held liable for damages and attorneys’ fees to the owner or contractor, subcontractor, or sub-subcontractor who suffers damages as a result of the filing of the fraudulent lien. In other words, not only would there not be payment for the work performed, a judgment could be rendered against the contractor for the amount of the claim of lien, plus attorneys’ fees.

Moreover, there are criminal penalties associated with violating Section 489.127(4), Florida Statutes. A first conviction for violating Section 489.127(4) is a first-degree misdemeanor. A first degree-misdemeanor can be punishable by a term of imprisonment not to exceed one year, and/or a fine not to exceed $1,000.00. See §§ 775.082(4)(a), 775.083(1)(d), Fla. Stat.

Each subsequent conviction for violating Section 489.127(4) is a third-degree felony. The penalty for a third-degree felony can be a term of imprisonment not to exceed five years, and/or a fine not to exceed $5,000.00. See §§ 775.082(3)(d), 775.083(1)(c), Fla. Stat.

If there is any question about compliance with Section 489.127, Florida Statutes, the prudent step is to obtain professional advice before taking any action.

Daniel T. Young
850/878-3700
dtyoung@smithcurrie.com

490 Challenges to Arbitration Enforcement

Arbitration continues to be strongly favored under state and federal law. Several recent decisions illustrate the courts’ willingness to enforce an arbitration provision in a contract, absent an irreconcilable conflict with another contract provision. In short, once a party seeking to invoke an arbitration provision establishes the existence of an agreement to arbitrate, any subsequent doubt surrounding the arbitration provision will likely be resolved in favor of arbitration.

Forum Selection Clause

In New Concept Construction Co, Inc. v. Kirbyville Consolidated School District, 119 S.W.3d 468 (Tex. App. 2003), the court held that a forum selection clause in a public contract, which required that the contractor institute any action or proceeding “in a court of competent jurisdiction,” did not irreconcilably conflict with an arbitration clause contained in the same contract.

In New Concept, the contractor entered into a contract with the school district for the construction of a high school gymnasium. The parties’ contract contained a “Disputes” resolution clause that required the contractor to institute any action or proceeding related to the parties’ agreement in a court of competent jurisdiction in the county in which the work was performed. In addition to this forum selection clause, the contract’s General Conditions also contained a section requiring arbitration. According to the school district, these two provisions conflicted with each other and prevented the court from finding that a valid arbitration agreement existed or that the parties had intended to arbitrate the disputes under the contract.

The court in New Concept determined that every provision in a contract, to the extent possible, must be interpreted in a way that gives effect to the entire agreement and harmonizes potential conflicts between differing provisions. Citing several decisions in which a similar forum selection or venue clause had been harmonized with an arbitration provision, the court held that the forum selection clause was consistent with the arbitration provision—in other words, the forum selection clause did not specifically exclude arbitration. In addition, the court looked to the Texas General Arbitration Act (“Act”) and acknowledged that the Act contemplated the trial court’s involvement in the arbitration context under certain specified circumstances (i.e., vacating, correcting or modifying an award, entering judgment on an arbitration award). Interpreting the forum selection clause and the arbitration clause together, the court in New Concept held that the contractor was required to file any court proceeding not precluded by the arbitration provision in the county in which the work was performed. Given the absence of any conflict between the two provisions that could not be harmonized, the court ordered the parties to resume arbitration of the contractor’s wrongful termination claim.

Arbitration Too Costly

In similar spirit to the challenge raised in New Concept against an arbitration provision due to a forum selection clause, the court in Pro Tech Industries, Inc. v. URS Corp., 377 F.3d 868 (8th Cir. 2004)(applying Texas law) rejected a subcontractor’s argument that an arbitration provision was unenforceable and unconscionable because the subcontractor could not afford arbitration.

In Pro Tech, a contractor which had been awarded a contract for construction of an environmental reclamation facility in Missouri, invoked the arbitration provision contained in its contract with the piping subcontractor. Among the subcontractor’s challenges to the arbitration provision was the contention that the prohibitive costs of arbitration presented a hardship to the subcontractor and therefore, rendered the arbitration provision unenforceable. Rejecting this argument, the court in Pro Tech concluded that there was nothing unconscionable about the arbitration provision, a contractual provision that the parties had agreed to and that conferred the same rights and responsibilities on both parties. Applying Texas law, the court held that only the circumstances at the time of contract formation are considered to determine if a contract is unconscionable. Here, both parties were businesses that had held themselves out as sophisticated entities able to negotiate a $400,000 government construction contract. Considering the parties’ commercial backgrounds and the contractual arbitration provision agreed to by both parties, the court compelled arbitration of the dispute.

Insertion of “N/A” in the “Architect” Section of AIA Contract

Contrary to the circumstances found in New Concept and Pro Tech with the courts’ findings of an unmistakable agreement to arbitrate between the parties, an ambiguity that directly calls into question whether such an agreement was ever made will increase the likelihood that an arbitration provision may not be enforced.

In Ritchie’s Food Distributor, Inc. v. Refrigerated Construction Services, 2004 WL 957659 (Ohio Ct. App. 2004), a contractor and a corporation, Richie’s Food Distributor (“RFD”) entered into an agreement for the construction of a refrigerated warehouse in southern Ohio. After the contractor’s completion of the project, RFD refused to pay $40,000 of the contractor’s final bill due to RFD’s belief that problems remained with the construction of the warehouse. In response, the contractor demanded arbitration pursuant to an arbitration provision contained in the parties’ contract. RFD subsequently filed a complaint for breach of contract and a motion to enjoin arbitration.

At the court hearing, the parties presented a copy of a standard form AIA contract in which the parties had designated both the owner and contractor. Under the heading for the architect, however, the parties had inserted an “N/A.” The parties stipulated that they did not intend to designate an architect, and that no architect was involved in the execution of the contract. The arbitration provision was contained in a section of the AIA contract entitled, “ARCHITECT’S ADMINISTRATION OF THE CONTRACT.”

The court in Ritchie found it problematic that the arbitration provision was found in the section concerning the architect’s administration of the contract, given the parties’ stipulation that no architect had been designated or would be involved in the execution of the contract. In addition, the owner, RFD, presented evidence at the hearing that the parties never adhered to the provisions of the contract relating to an architect (i.e., architect’s certification before progress payments become due). Given these facts, the court held that it would be reasonable to interpret the parties’ contract as excluding all sections that pertained to the architect, including the arbitration provision. Therefore, the court held that there was competent, credible evidence that the parties had not reached an agreement to arbitrate disputes arising under the contract.

Conclusion

Arbitration boils down to a matter of contract. Unless and until the existence of an agreement to arbitrate is itself established, courts must ascertain the parties’ intent under general principles of contract law. Courts endeavor to interpret a particular contractual provision in such a way that gives effect to the entire agreement and harmonizes potential conflicts between differing provisions. However, it is imperative for a party interested in arbitration as the preferred method for dispute resolution to ensure that the existence of the parties’ agreement to arbitrate is clearly established in the contract. Once such an agreement is established, courts should resolve any ambiguities or doubts regarding any further scope of the arbitration provision in favor of arbitration.

Mark Farrell
404/582-8040
mefarrell@smithcurrie.com

491 “Float Time” - Defining the Term

Overview

Construction projects, like most complicated business ventures, will occasionally fall prey to costly disputes which arise for various reasons. Often these disputes are prolonged by uncertainty over the meaning of a contract term or provision. While all disputes cannot be prevented, one relatively inexpensive method of avoiding or shortening the claims process is to utilize contract documents that define all key contract terms. This effort may help the parties to have a clear understanding of their rights and obligations from the beginning of the project.

Many contractors and owners use “float time” ownership clauses that are intended to allocate the benefit of extra time in the project schedule. While the term is commonly used in construction contracts, drafters may not have defined that term in their construction agreements. This is because “float time,” until recently, has not been held to be an ambiguous or vague term in any reported United States decision. But, in April, 2004, the ambiguity of the term “float time” was an issue in Constr. Enter. & Contractors, Inc. v. Orting School Dist. No. 344, 121 Wash. App. 1012 (hereinafter, “Orting”). This decision provides a very useful example of how a dispute may be prolonged by the lack of a definition of a key term.

The Orting Decision

In Orting, the dispute involved a claim by the general contractor against an engineering subcontractor. The contractor claimed that the engineer’s faulty grading, water, and sewer plans caused it to frequently stop work and incur over $700,000 in disruption damages. However, in spite of the disruption and work stoppage due to the alleged poor design, the contractor was able to finish the project by the contract deadline. Nevertheless, the contractor sought to hold the engineer liable for “damages resulting from the continuing disruption, loss of productivity, inefficiencies, and extended performance costs based on the inadequate design and the continuing failure to provide timely fixes for the design deficiencies.”

In its defense, the engineering subcontractor sought to use the clause in the prime contract titled “Float Time.” This clause, like others found in many similar contracts, stated that:

The inclusion of float time in the activity listing of the Contractor’s Construction Schedule shall be owned entirely by the Owner. The Contractor shall not be entitled to any adjustment in the Contract Time, the Contractor’s Construction Schedule, or the Contract Sum, or to any additional payment of any sort by reason of the loss or use of any float time, including time between the Contractor’s anticipated completion date and the actual completion date.

In using this clause, the engineer argued that because the owner of the project “owns” the benefit of any float time in the project, the contractor cannot recover for the lost time or work stoppage where the contract is finished on time because the contractor never had a right to the benefit of that time. This argument proved successful at the trial court level as the engineering subcontractor won summary judgment on the contractor’s claim.

However, on appeal, the contractor was able to convince the appellate court that the engineer’s reading of the contract was incorrect and that its claims should have been fully heard in the lower court. The contractor argued that “float time” referred to “the excess time scheduled on various side path activities which are not on the critical path, and thus will not delay the entire project” and did not have the expansive meaning as suggested by the engineer’s argument. The contractor also argued that, while the “float time” clause may prohibit some “delay” claims for non-critical path activities, its claims were for “disruption of productivity” of both float and non-float activities and were not governed by that clause. Essentially, the contractor was trying to say that its claims had nothing to do with float time or delay; it was damaged when its work was disrupted and made inefficient by the engineer’s faulty plan.

The Washington Court of Appeals appeared to accept the contractor’s suggested reading of the clause. The court’s language in its decision clearly gave the impression that it appreciated the contractor’s distinction between disruption and delay damages. However, in its ruling, the Court of Appeals merely held that the lower court wrongly awarded summary judgment to the engineering subconsultant. The court found that because “float time is not defined in the contract” and is not “a commonly understood term,” an issue of material fact existed as to the meaning of the term and whether the float time language barred some or all of the contractor’s claims. This meant that the case went back to the lower court to determine the proper definition of “float time” and whether the “ownership of float time” clause governed the contractor’s disruption claims.

Comment

In Orting, the contractor argued that “float time” should mean “the excess time scheduled on various side path activities which are not on the critical path, and thus will not delay the entire project.” Many construction industry professionals would likely agree that the contractor’s definition appears to be a reasonable meaning for the term. In addition, a court using the contractor’s definition of “float time” might hold that the contractor did not waive disruption damages under the “ownership of float time” contract clause.

However, the contractor in Orting was forced to take several steps, costing time, money, and bargaining power, in order to have its underlying claims heard. The contractor first lost as a matter of law in the trial court due to the engineer’s argument that the float time clause barred the contractor’s disruption claim. The contractor then took its chances on appeal where it managed to overturn the engineer’s victory in the trial court. At this point, because the appellate court found the term “float time” to be ambiguous, the contractor was forced to go back to the trial court and argue its definition of the term again. Throughout this process, the engineer likely enjoyed a degree of leverage in settlement negotiations due to possibility that the court would not reverse the previous decision. Further, the contractor continued to suffer the costs of prolonged litigation until the matter was resolved.

A few key steps could have saved the contractor a great deal of expense and uncertainty. First, the contractor could have provided that its definition of “float time” be incorporated into the construction agreement. This step would have reduced the likelihood that “float time” would be considered an ambiguous term and open to interpretation by a court. Second, the contractor could have made sure that the “ownership of float time” clause expressly excluded damages for disruption from its coverage. This additional step would have completely negated the engineer’s argument that because the contractor finished on time, its disruption damages were not recoverable. While the inclusion of such provisions into construction agreements are not always feasible or useful, it could substantially decrease the potential of a contractor suffering unnecessary time and expense litigating the meaning of what was believed to be a well-understood term.

James B. Taylor
404/582-8048
jbtaylor@smithcurrie.com

492: South Carolina: Standard of Care for Highway Contractors

The South Carolina Supreme Court recently decided that even after the SCDOT takes over maintenance of a project, a highway contractor still owes a duty of care to protect the traveling public on the basis of (1) the contractual relationship between the contractor and the SCDOT, and (2) a common law duty of care to foreseeable third-party users of the highway. One of the most distressing aspects of this decision is the fact that the duty appears to continue long after the state accepts responsibility for maintenance of the highway.

In Dorrell v. SCDOT, 605 S.E. 2d 12 (S.C. Sep. 27, 2004), the South Carolina Supreme Court reversed and remanded for trial a case in which the highway contractor had been granted summary judgment in its favor. In Dorrell, the highway contractor, APAC, had resurfaced an existing roadway in Georgetown County under a contract with the SCDOT. The plaintiff was injured in a single car accident when an alleged “gust of wind” caused the plaintiff’s car to veer to the right and drop off the resurfaced roadway onto a dirt shoulder which was 11”-12” below the surface of the roadway after the resurfacing. The resurfacing had added 3” to the existing roadway elevation. The plaintiff lost control of the car, the car rolled several times, and the driver was thrown from the car into a ditch 25’ – 30’ away. The driver suffered permanent injuries and incurred significant medical bills. (There is no mention in the reported decision whether the driver was using a seat belt at the time of the incident.)

Factual Background

The roadway had recently been repaired by APAC pursuant to a written contract between APAC and the SCDOT. Only six days after the accident (which occurred on April 16, 1996) the SCDOT issued its notice of acceptance of the roadway and returned the highway to State maintenance as of November 17, 1995—almost five months prior to the accident.

The plaintiff sued APAC for negligently:

• Failing to perform the contract according to the 1986 Edition of the SC State Highway Department Standard Specifications for Highway Construction (the “Red Book”);
• Creating a dangerous condition by raising the roadway above the shoulder;
• Failing to correct a dangerous condition;
• Failing to warn motorists about a dangerous condition;
• Failing to exercise the degree of care that a reasonable and prudent highway contractor would have exercised in the circumstances; and
• Failing to inspect the road and detect a dangerous condition.

APAC defended against plaintiff’s claims by contending that its contract with the SCDOT did not authorize it to “…rebuild, repair or maintain…” the shoulder area, and that the specifications for the contract required only that the shoulder area be left in a “…neat and presentable condition….” In contrast, the plaintiff’s expert described the difference in elevation as an “…intolerable and gross defect…” which was a “…well known, clear, immediate, and compelling danger to the motoring public.”

Despite APAC’s protestations (1) that rebuilding, repairing, or maintaining the highway shoulders was not within the scope of its contractual obligations; (2) that APAC’s work had been completed as of November 17, 1995, the effective date of the SCDOT acceptance of the highway for maintenance; and (3) that the SCDOT was solely responsible for the roadway and shoulders at the time of the accident (and had been for five months), the South Carolina Supreme Court held that the APAC-SCDOT contract did not limit APAC’s liability for negligently causing injury to third parties and that APAC could be held liable under the common law of South Carolina.

Analysis of Contractor’s Duty

The court’s rationale was premised, at least in part, on provisions of the SCDOT’s standard specifications, the “Red Book,” which were incorporated by reference into the APAC-SCDOT contract, and from language from the Required Contract Provisions Federal-Aid Construction Contracts also made a part of the APAC-SCDOT contract.

The specific provisions from the Federal-Aid Construction Contracts relied upon by the court included :

Safety: Accident Provision

The Contractor shall provide all safeguards, safety devices and protective equipment and take any other needed actions as it determines…to be reasonably necessary to protect the life and health of employees on the job and safety of the public…

The court also cited ¶107.09 of the Red Book that provides:

Public Convenience and Safety. The Contractor shall at all times conduct work in such a manner as to provide for and insure the safety and convenience of the traveling public…

(Query whether the two quotations relied upon by the court were intended to ever apply to circumstances similar to those in this case.)

Interpreting the foregoing contract language provisions and the South Carolina common law, and applying that interpretation to the facts of the Dorrell case, the court concluded that the driver was a foreseeable plaintiff and that APAC therefore owed a duty to Dorrell to protect the driver from this dangerous condition existing at the project. The court summed up its conclusions by stating “We join the majority of jurisdictions in deciding that a contractor’s duty of care is not extinguished upon the completion and acceptance of the contractor’s work. APAC cannot escape liability simply by completing its work and having it accepted by SCDOT. APAC had a duty that extended above and beyond compliance with the contract…”

Comment

The South Carolina Supreme Court remanded the case for a jury trial as to whether APAC had violated the duty of due care to this plaintiff as articulated in the opinion of the court. However the jury decides the negligence issues in this case, or if the case is settled without further trial, the South Carolina Supreme Court has now unequivocally established a standard of care for performance by highway contractors on projects with the SCDOT. It now appears certain that in order to avoid liability to third parties using the highways on which they have worked, South Carolina highway contractors must shoulder the burden of determining the existence of unsafe conditions created or existing at the project—even if correction or remediation of those unsafe conditions is outside the scope of their contractual obligations to the SCDOT, and whether created by the contractor or by a previous cause. The court’s specific language was that the contractor’s legal obligation is to “…provide all safeguards and take any other needed actions as it determines…to be reasonably necessary to protect…the safety of the public…and…to provide for and insure the safety and convenience of the traveling public…” (Emphasis added) Further, this obligation (potential liability) continues even after completion and acceptance of the project by the SCDOT. Contractors performing highway work in South Carolina must consider this risk and potential liability in evaluating any project in that state. Project procedures need to be addressed to adequately protect the contractor's potential rights under the contract and to minimize the potential for plaintiff’s claims similar to those in the Dorrell decision.

Robert J. Greene, Jr.
704/334-3459
rjgreene@smithcurrie.com

493 Demands on Sureties

Introduction

A surety’s obligations pursuant to a performance bond are contractual in nature. Just as contracts frequently contain notice requirements that must be met in order for liability to arise, so do performance bonds. Generally speaking, the purpose of requiring notice as a condition precedent to asserting liability on a bond is to allow a surety an opportunity to investigate the alleged default and to determine how best to proceed with regard to such matter. Courts typically enforce these types of notice provisions. As a result, where an obligee takes action to correct a default of a bonded principal without first complying with the notice provisions of the bond, it may be unable to subsequently make a successful claim to recover its losses. This was the situation in Elm Haven Construction LP v. Neri Construction LLC, 376 F.3d 96 (2nd Cir. 2004), and the United States Court of Appeals for the Second Circuit had no trouble in holding that the surety in that case was entitled to summary judgment as to general contractor’s claim against a subcontractor’s performance bond.

Factual Background

Elm Haven, the general contractor on a construction project, subcontracted certain work on the project to Neri. As one of its obligations pursuant to its subcontract, Neri furnished a performance bond. The performance bond furnished by Neri contained the following provision outlining the procedure to be followed in the event that Neri defaulted on its subcontract:

Whenever Principal [Neri] shall be, and be declared by Obligee [Elm Haven] to be in default under the subcontract, the Obligee having performed Obligee’s obligations thereunder:

(1) Surety may promptly remedy the default subject to the provisions of paragraph 3 herein, or;

(2) Obligee after reasonable notice to Surety may, or Surety upon demand of Obligee, may arrange for the performance of Principal’s obligation under the subcontract subject to the provisions of paragraph 3 herein;

(3) The balance of the subcontract price, as defined below, shall be credited against the reasonable cost of completing performance of the subcontract.

Not long after Neri began performance of work, Elm Haven began to complain about Neri’s performance. Elm Haven sent several letters to Neri, which were copied to the surety, detailing those complaints. In addition, Elm Haven also sent other letters addressed to the surety requesting its “assistance in this matter.” Then, beginning in April, 2001, Elm Haven sent several letters informing Neri and the surety that certain portions of Neri’s work would be performed by others because, Elm Haven alleged, Neri had failed to perform that work or had claimed that it was not contractually required to perform it. Those letters culminated in a letter dated April 30, 2001, in which Elm Haven stated that “because Neri had failed to perform certain parts of its work, Elm Haven ‘hereby provides notice to [Neri] that this work will be performed by others in accordance with’ the default provisions of the subcontract agreement.”

Then, on May 17, 2001, Elm Haven entered into a contract with another subcontractor to replace Neri on the project. More than a month after that, on June 26, 2001, Elm Haven wrote to the surety and made a claim against the performance bond, stating that it had been “forced to supplement Neri’s forces in completing the balance of the work” and that Neri had “virtually abandoned the project as of April 30.”

The surety denied the claim on the grounds that Elm Haven had failed to comply with the terms of the bond by not making a declaration of default and that Elm Haven’s unilateral action in hiring a replacement contractor precluded the surety from performing an investigation and exercising its options pursuant to the bond. Elm Haven replied that it had declared Neri to be in default in its April 30, 2001 letter, and that, as a result, the surety was liable pursuant to the bond.

Elm Haven then filed suit against the surety and Neri, seeking to obtain a judgment against the bond along with other relief. The surety filed a motion for summary judgment as to the claim against the bond, which motion was granted, and Elm Haven appealed.

Second Circuit’s Opinion

The court began its analysis by stating that a performance bond is a contract and that standard principles of contract interpretation apply in order to determine the rights and obligations of a surety pursuant to such a bond. The court then stated that one such principle is the requirement that any conditions precedent must be complied with before a surety’s obligations under a bond mature.

Addressing the default provision contained in the performance bond, the Second Circuit held that in order to trigger the surety’s liability under the bond, two conditions precedent had to be met:

(1) Neri had to be in default under its subcontract; and

(2) Elm Haven had to actually declare Neri to be “in default” and make that declaration to the surety “in precise terms.”

The court concluded that the notice of default requirement was not met until the June 26, 2001 letter. In reaching this conclusion, the court construed Elm Haven’s earlier letters as, at best, merely notifying Neri and the surety that Elm Haven was exercising its rights under the default provisions of the subcontract, but that despite the exercise of those rights Elm Haven desired to continue its arrangements with Neri. The court noted that if Elm Haven had desired to trigger the surety’s obligations under the performance bond it would have had to have actually terminated the subcontract and given the surety an opportunity to complete the project itself or arrange for another contractor to complete the work. Instead, while some of Elm Haven’s letters (prior to June 26, 2001) did notify the surety that part of Neri’s work would be performed by others, the court determined that those letters all indicated that Elm Haven intended for Neri to continue to perform some work and requested nothing more from the surety than help in improving the ongoing relationship with Neri.

The court concluded that, by the time the June 26, 2001 letter, which did constitute a declaration of default, had been sent, Elm Haven had already breached its obligations to the surety under the performance bond and failed to allow the surety the option to cure Neri’s default. Thus, the Second Circuit held that Elm Haven had failed to comply with the conditions precedent contained in the performance bond and affirmed the summary judgment that had been granted by the trial court in favor of the surety excusing it from performance pursuant to its bond.

Practical Implications

The lesson to be learned from this case is that a surety is entitled to the benefit of the applicable contractual conditions precedent set forth in its bonds. An obligee, whether it is a project owner or a contractor, cannot sit back and expect the surety to remedy any default of its principal, without the obligee first performing its obligations pursuant to that bond. Accordingly, in order to protect its rights under a performance bond, an obligee on a bonded project should carefully read the bond and make sure that it complies with all requirements of that bond in the event of a default by the bonded principal. In addition, an obligee should make sure that it not only gives all notices required by the bond, but also that it clearly demands that the surety perform pursuant to its bond. Furthermore, such notice and demand should be made – to borrow the language of the opinion -- “in precise terms,” so there is no doubt that the surety is being called upon to actually perform pursuant to its bond. Then, after that notice is given and that demand is made, the obligee should allow the surety the opportunity to take any action permitted to it pursuant to the bond.

In Elm Haven, there was no doubt that Elm Haven was dissatisfied with Neri’s performance. Elm Haven had delivered a whole series of letters complaining about that performance and requesting the surety’s “assistance”. Elm Haven even sent a letter stating that it was hiring a replacement contractor “in accordance with the default provisions in the contract.” However, after that letter, Elm Haven did not immediately take action, but instead waited seventeen more days before hiring a replacement contractor, which might have been sufficient time for the surety to investigate and make a determination about performance. In the court’s view, Elm Haven made the mistake of never making it inescapably clear that it considered Neri to be in default and never unambiguously demanding that the surety remedy that default or otherwise perform its obligations pursuant to the bond. Consequently, the surety, having not been properly notified of a default by its principal or called upon to perform, was within its rights to do nothing. Only after it had replaced Neri, did Elm Haven actually demand performance from the surety and by then it was too late.

Andrew R. McBride
404/582-8063
armcbride@smithcurrie.com

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