In the March 2014, Attorney’s Column, I mentioned that the City of New York revised its standard contract to eliminate the “no-damage-for-delay” provision and allow claims for delay-related costs under certain circumstances.

Background

In September 2008, the City began a five-year pilot program to test the use of new contract language which would allow delay claims on certain public works projects. The City’s goal was to determine whether some contractors decline to bid on City projects because of delay risks, and whether those who do so are factoring such costs into their bids because they cannot predict what will happen if delays do occur. The contracts on pilot projects eliminated the “no-damage-for-delay” clause. Instead, the contract allowed compensation for delays caused by City agencies.

After completing the pilot study, the City found that the bid prices on projects containing the “no-damage-for-delay” clause were higher than comparable projects where claims were allowed for delay-related causes—which should not have come as a surprise to the City. The demonstrated savings to the City was sufficient justification for the City to revise its standard contract language by eliminating the “no-damage-for-delay” clause and allowing delay damages in limited circumstances on all City construction projects starting after December 24, 2013.

Compensable Delays

The revised Article 11 identifies the type of delays that are compensable, including the four exceptions to the enforcement of the no-damage-for-delay claims made by the Court of Appeals in Corino Civetta Constr. Corp. v City of New York, namely: (1) the City’s bad faith, willfulness, or grossly negligent conduct; (2) uncontemplated delays; (3) unreasonable delays that constitute intentional abandonment by the City; and (4) delays resulting from the City’s breach of a fundamental obligation of the contract.

Other delays allowing a contractor to recover damages include: (5) the City’s failure “to coordinate and progress the work”; (6) extended delays in reviewing and approving change orders, in shop drawing reviews and approvals, or delays resulting from the “cumulative impact of multiple change orders”; (7) unavailability of the site for an extended period of time that significantly affects the scheduled completion of the contract; (8) stop work orders exceeding 30 days relative to a substantial portion of the work; and (9) differing site conditions that were not known or reasonably ascertainable on a pre-bid inspection of the site or review of the bid documents or other publicly available sources and are not ordinarily encountered in the geographical area of the site or in the type of work to be performed.

The revised contract language specifically excludes claims for delays caused by third parties, such as contractors, non-City agencies, utilities, labor strikes or disputes, and “any situation which was within the contemplation of the parties at the time of entering into the contract.”

Notice Requirements and Documentation

Article 11 provides for written notice of any delay conditions to the City’s engineer within seven days of the commencement of the condition. This article further provides that a verified statement and supporting documentation of the details of the delay and the amount of compensation claimed is required to be submitted within forty-five days from the time the damages are first incurred. Thereafter, an updated verified statement and supporting documentation must be submitted every thirty days.

The notice and documentation requirements will be strictly enforced. Failure to comply with the notice requirements will constitute a waiver of the delay claim.

Comment

The elimination of the onerous “no-damage-for-delay” clause on New York City public contracts and the inclusion of recovery for delay damages under certain circumstances is a step in the right direction. It is only fair that contractors be allowed to recover damages for City-caused delays. The taxpaying public also benefits because contractors will not be factoring in their bid prices the projected additional costs needed to cover unpaid delays on the project, thereby reducing the overall cost of the project. Under the revised contract, contractors will now have contractual protections that will include compensation for delays that are reasonably considered to be the City’s own responsibility.

The next step is to eliminate the “no-damage-for-delay” clause from all statewide public contracts. Last year, the New York State Senate passed a bill allowing damages for delay which was similar to the language in the City’s revised contract. The Assembly did not follow suit. Given the City’s allowance of delay claims under the revised standard contract, perhaps the Assembly will be more receptive to enacting a “damages for delay” bill on public works projects throughout the State.

Courts have traditionally recognized that in every contract an implied duty of good faith and fair dealing exists between the parties that govern their respective contract performance and enforcement.

Despite the efforts of the courts in determining when and how the covenant of good faith and fair dealing is violated, the definitions of “good faith” and “fair dealing” remain obscure. In the recent case of Helmar Construction v 1198934 Ontario, Inc., however, the court found that a supplier’s conduct in dealing with a subcontractor constituted a breach of the covenant of good faith and fair dealing.

Background

Prior to 2004, Helmar undertook to perform certain curtain wall installation at the construction of the Queens Ambulatory Pavilion at Queens Hospital Center. In 2004, Helmar contracted with Ontario for it to supply materials required for Helmar to perform its own subcontract which included, among other items, certain items of aluminum curtain wall, storefronts, glazing, windows and other hardware. Ontario was also required to supply shop drawings and complete field measurements.

From the beginning of the project there were issues with Ontario’s performance, including its delays in delivering its materials and its delivery of defective, damaged and otherwise nonconforming materials. Helmar had repeatedly attempted to discuss these issues with Ontario by making numerous telephone calls and sending repeated letters and faxes. Helmar’s repeated attempts to resolve these issues often went ignored and unanswered. As a result, Helmar sustained backcharges from the general contractor. Helmar sued Ontario for breaching the contract, and Ontario claimed that its slow delivery and lack of responsiveness was justified by Helmar’s withholding of a disputed 10% retainage.

Decision

After a trial, the court held that under the circumstances of Ontario’s failing to respond to Helmar’s concerns about problems with Ontario’s materials, Ontario had breached the contract by breaching the covenant of good faith and fair dealing. The court held that even assuming that Helmar was not justified in withholding 10% retainage, Ontario’s failure to respond to Helmar’s calls and correspondence went well beyond any resulting cash flow problem and was well outside of what could be considered good faith or fair dealing.

Comment

Although the duty of good faith and fair dealing between the parties is implied in every contract, it is rarely used by the courts in contract litigation. In this case, however, the Court made it clear that parties to construction contracts have not only the obligation to live up to the obligations under that contract, but to attempt to resolve problems that arise in a timely fashion, and in good faith. Parties to such contracts would accordingly be well advised that when a problem arises they should not ignore repeated written requests from the other party and should respond to the other party’s requests within a reasonable time otherwise they face the possibility of liability for breaching the covenant of good faith and fair dealing.

Extra work claims by contractors are a major source of construction litigation. In the recent case of Mid-State Industries v State of New York, a contractor sought additional compensation for extra work, claiming that it relied on the State’s drawings showing 33,100 square feet of roof work. The contractor later discovered that the total area of the roof work was 47,200 square feet. According to the contractor, this error caused it to perform an additional 14,100 square feet for which it sought additional compensation.

Background

Mid-State submitted a bid to SUNY for a project to replace the roof of a library located on the campus of SUNY Plattsburgh. Mid-State’s bid was based upon, among other things, an architectural drawing of the roof that was provided to prospective bidders with the project manual, and an addendum to that drawing noting that the scale should be one sixteenth rather than one eighth. Relying on these documents, Mid-State determined that the roof was 33,100 square feet and submitted a bid based on those documents. SUNY accepted Mid-State’s bid and entered into a contract with Mid-State for the roof replacement. After Mid-State completed a significant amount of work on the project, it noticed that it was short on materials. Mid-State then measured the remaining part of the roof and determined that the total area was actually 47,200 square feet. Mid-State then determined that the scale on the drawing (that had been corrected in the addendum) was still erroneous. Based on that error, Mid-State realized that it had underestimated the cost of materials and labor by about one third. Mid-State notified SUNY and SUNY's architect of this problem, completed the project and submitted requests for payment for the "extra work". When SUNY refused to pay, Mid-State commenced a lawsuit against the State. The State moved for summary judgment dismissing the claim, and Mid-State cross-moved for partial summary judgment on the issue of liability.

Decision

The Court of Claims granted the State’s motion to dismiss Mid-State’s lawsuit, and the appellate court affirmed. In doing so, the appellate court noted that the primary guide in determining whether a contractor is entitled to extra work are the contract documents. Where the contract reveals that the parties intended for the contractor to rely on its own investigation, no recovery for extra work may be had absent a showing of fraud or misrepresentation as to existing conditions. Here, the contract and bid documents contained a specific representation that Mid-State carefully examined all of the contract documents, personally inspected the worksite and “has satisfied itself as to all the quantities and conditions, and understands that in signing this Proposal, it waives all right to plead any misunderstanding regarding the same”. The appellate court held that Mid-State’s reliance on the scale in the state’s drawings could not rescue its extra work claim because a pre-bid inspection—which Mid-State represented it had made—would have revealed the actual dimensions of the roof area. The court noted that Mid-State attended a pre-bid meeting at the site, during which some potential bidders took measurements of the roof.

The appellate court also rejected Mid-State’s argument that the issuance of an addendum containing the (incorrect) revised scale superseded the contract documents—and particularly the provision requiring Mid-State to inspect the worksite. The contract here unambiguously stated that the contract documents (which include the addenda) are to be "complementary", and that requirements of one "shall be as binding as if called for by all". The appellate court held that this language demonstrates the parties' intent to harmonize the contract documents rather than pursue an interpretation that would render some provisions meaningless.  Accordingly, the court ruled that the language modifying the scale on one drawing was sufficient to supersede the scale on any prior drawing. The addendum did not supersede the contract language concerning Mid-State’s obligation to perform its own investigation and to not rely on SUNY's estimates.

Comment

In the face of cautionary contractual language providing for a pre-bid investigation of the site, a contractor would be well-advised to conduct a pre-bid site inspection to verify the site conditions and dimensions. A contractor cannot expect to recover for extra work based on misrepresented conditions or dimensions where the contractor is contractually required to conduct its own pre-bid site investigation which may reveal inaccuracies.

Public construction contracts are subject to New York’s competitive bidding statutes. They provide that contracts be awarded to the lowest responsive and responsible bidder. A responsive bidder is a contractor who has complied with the strict requirements of the bid documents. Whether a bid is responsive to the bid specifications is a frequent cause of litigation in the bid selection process, as shown in the recent case of Matter of Amcon Contracting Corp. v Dormitory Authority of the State of New York.

Background

In January of 2013, Amcon Contracting Corp. submitted a bid to the Dormitory Authority of the State of New York to perform exterior restoration and asbestos abatement at the Helen Hayes Hospital. In June, DASNY awarded the contract to Amcon. DASNY, however, rescinded the award after it had been advised that Amcon was suspended from the New York City School Construction Program. DASNY re-bid the project, and Amcon was once again the low bidder. This time, DASNY rejected Amcon’s bid on the grounds that it was not responsive to the solicitation because it failed to include a unit price worksheet. DASNY’s rejection determination was challenged by Amcon in an Article 78 proceeding.

In its Article 78 proceeding, Amcon maintained that the bid documents did not require the unit price worksheet, but even if they did, the failure was a “minor informality which should have been waived”.

Decision

The court dismissed Amcon’s challenge, holding that the bid specifications specifically required the submission of a unit price worksheet. As to Amcon’s argument that the failure to submit the worksheet was a “minor informality”, the court did note that the values scheduled on the worksheet amounted to only $34,435, or a mere 1.57% of Amcon’s overall $2,199,000 bid. However, the court held that the failure to submit this worksheet in the first place deprived DASNY of the opportunity to determine whether the information which was to have been submitted was, in fact, minor. Therefore, the court could not conclude that a $34,435 discrepancy, even though proportionately small when compared to the overall bid, was actually immaterial.

As to the argument that DASNY had the discretion in the bid documents to waive irregularities, the court held that this power was written into the bid specifications for DASNY’s benefit, and that DASNY was not required to waive the submission for Amcon’s benefit.

Comment

Here, the Amcon court applied well settled case law to hold that the determination of a public agency that a variance from the bid specifications is material will be upheld by the courts if the agency’s determination of a non-responsive bid is supported by any rational basis.

Contractors would be well advised to strictly comply with the bid instructions. Public agencies have broad discretion in both determining what constitutes compliance with the bid documents, as well as what items of compliance they choose to waive—provided that the waiver is a technical noncompliance or a mere irregularity. An agency, however, may not waive a material noncompliance with a bid specification because the waiver would give the bidder an unfair competitive advantage over other bidders.

Mr. Miuccio is a partner of the law firm of Welby, Brady & Greenblatt, LLP and General Counsel to the Construction Industry Council of Westchester & Hudson Valley, Inc. and the Building Contractors Association of Westchester & the Mid-Hudson Region, Inc. Gregory J. Spaun, a partner with the firm, assisted with the writing of this article.

Delay claims are a frequent subject of construction litigation. To reduce the risk of delay claims, many owners and general contractors include a “no damages for delay” clause in their contracts. This provision essentially prevents a general contractor or a subcontractor from recovering monetary compensation for delays that occur on a construction project. This clause is found in both public works contracts and private construction contracts.

New York courts rigorously enforce the “no damages for delay” clause, as shown in the recent case of Polo Electric Corp. v New York Law School.

Background

In 2007, Polo entered into a construction subcontract with Pavarini McGovern  to perform electrical work for the construction of New York Law School’s new building. The contract contained the following broadly worded “no damages for delay” clause:

“[Polo] expressly agrees not to make, and hereby waives, any claim for delay costs, loss of productivity or efficiency, lost profits or extended home office overhead, on account of delay, obstruction or hindrance for any cause whatsoever, whether or not foreseeable, whether or not anticipated and whether or not caused by [Polo].”

Pursuant to Polo’s contract, its work was supposed to have been completed by August of 2008. Despite this requirement, Polo was only given access to its principal work areas in July and August of 2008. An oral understanding was reached in which it was acknowledged that the original contract schedule was not achievable, and that Polo’s time to complete was extended until December. When Polo’s work areas were made available, the work environment was haphazard and disjointed such that Polo had to hire additional labor to meet the new deadline.

In early January of 2009, when the work was still not complete, Polo claimed that construction manager Pavarini accelerated the work schedule and assured Polo that any extra expenditures incurred in meeting the accelerated schedule would be reimbursed. Polo submitted additional work authorizations, T&M tickets, lump sum and proposed change orders and other correspondence documenting the work it performed to meet the accelerated schedule. Some of these submissions resulted in formal written change orders from Pavarini, and others were approved by email or orally. Ultimately, Pavarini declined to pay Polo for the extra work. When Polo demanded that Pavarini make payment, Pavarini responded by issuing a deduct change order removing all remaining work from Polo’s contract.

Polo sued on various theories to recover for the unpaid extra work. In response, Pavarini and the owner moved to dismiss the claims, arguing that all of the damages sought by Polo relate to the claimed delay, and that such claims are barred by the “no damages for delay” clause in the contract. Polo opposed, arguing that the “no damages for delay” provision is not enforceable because the delays were not contemplated by the parties at the time of contracting. New York courts have acknowledged that delay not contemplated by the parties is an exception to the enforceability of “no damages for delay” provision. Polo claimed that the delays arose out of the incompetent administration of the project and, therefore, were not contemplated by the parties at the time they entered into the contract. Polo also argued that the delays were caused by willful or grossly negligent conduct, which is another court-made exception to the enforceability of the “no damages for delay” clause.  

Decision

The trial court dismissed Polo’s delay claims, finding that it was barred by the broad language of the “no damages for delay” clause in its contract. The court rejected Polo’s argument that the root of the delays—inept administration and improper scheduling of the work of different trades—fall within the exceptions to the enforceability of a “no damages for delay” clause. The court noted that parties seeking to enforce the exceptions to the enforceability of such a clause face a “heavy burden”. Finally, the court noted that Polo failed to allege any willful or grossly negligent conduct which would have allowed it to recover as an exception to the no damages for delay clause.

On appeal, the appellate court affirmed the dismissal of the delay claims, holding that the causes of the delays were within the contemplation of the “no damages for delay” clause in the parties’ contract and, therefore, the clause was enforceable.

Comment

The “no damage for delay” clause is used by an upstream party to shift the risk of delay downstream. Downstream parties generally lack the bargaining power to change or delete the oppressive terms of a “no damages for delay” clause. The harsh consequence of a “no damages for delay” provision is that the contractor or subcontractor must absorb all of its monetary damages in connection with delays caused by others.

The City of New York took a step in the right direction by recently revising its standard construction contract to eliminate the “no damages for delay” clause and allowing a number of circumstances under which the contractor may be entitled to delay costs. It remains to be seen whether this change in the City’s contract will set a pattern of eliminating the one-sided and unfair terms of a “no damages for delay” clause.

About the author:  Mr. Miuccio is a partner of the law firm of Welby, Brady & Greenblatt, LLP and General Counsel to the Construction Industry Council of Westchester & Hudson Valley, Inc. and the Building Contractors Association of Westchester & the Mid-Hudson Region, Inc.  Gregory J. Spaun, a partner with the firm, assisted with the writing of this article.

A corporation has an existence separate and apart from that of its individual officers, directors and shareholders. The general rule is that individual owners of a corporation are insulated from personal liability for corporate debts, and that individuals may incorporate a business for the very purpose of limiting their personal liability.

In certain circumstances, however, corporate owners may be personally liable for corporate debt. In the recent case of PGC Construction Corp. v Fudge, a building owner attempted to hold a sole shareholder, officer and director of a construction company personally liable for the company’s obligations under a construction contract.

Background

PGC Construction was retained by the Fudges to construct a second floor addition and other improvements to their home for a fixed price, with progress payments to be made during the job. About halfway through the job, the homeowners terminated PGC for cause, claiming that PGC failed to adequately protect the home from rain, resulting in damage to the first floor. PGC filed a mechanic’s lien on the property, claiming that $67,493 was still owed to it for labor and materials. PCG ultimately sued to foreclose the mechanic’s lien, and the Fudges counterclaimed against PGC for the damages to the first floor, defective work and the cost to complete the project.

The homeowners’ counterclaim also included a suit against PGC’s sole shareholder, Peter Gmelch, claiming that PGC was under the sole control of Gmelch, was undercapitalized, did not hold regular corporate meetings, commingled corporate funds with Gmelch and otherwise failed to observe corporate formalities. As to the claim that PGC was undercapitalized, the homeowners argued that during the time that PGC was working on their home, they were informed by the HVAC contractor that PGC had bounced checks it had issued to him on prior construction jobs. They also claimed that an electrical subcontractor informed them that he agreed to work on their home “so that Gmelch would pay him the amounts that he owed in connection with the work that the electrical contractor had performed on a prior project.” They also argued that as the sole shareholder, officer and director of PGC, Gmelch is personally liable for wrongfully filing a “frivolous and willfully exaggerated” mechanic’s lien against their property.

Gmelch moved to dismiss the claims against him personally, arguing that the claims as to the underfunding and lack of corporate formalities are false, and that there is no legal basis for holding him personally liable. The homeowners opposed the motion, claiming that the evidence submitted by Gmelch was insufficient to establish that PGC was sufficiently capitalized, holds regular corporate meetings, does not commingle funds and otherwise follows corporate formalities.

Decision

The court dismissed all claims of personal liability against Gmelch. In doing so, the court noted that a business can be incorporated for the very purpose of avoiding personal liability. Nevertheless, a court may impose personal liability on its shareholders to prevent fraud or illegality, or to achieve equity. The court further noted that courts hold shareholders personally liable for the debts of the corporation when the shareholder exercised complete domination of the corporation with respect to the transaction at issue and abused the privilege of doing business in the corporate form to perpetrate a wrong or an injustice.

After discussing the high burden a party faces when it wishes to impose personal liability, the court held that the homeowners failed to state any particular facts as to how Gmelch abused the privilege of doing business in a corporate form to commit a wrong against them. The court also rejected the hearsay and conclusory statements of the homeowners regarding PGC’s dealings with other contractors.  

Comment

The very purpose of doing business in the corporate form is to avoid personal liability for corporate debts. As this case demonstrates, the burden to hold a shareholder personally liable for the debts of the corporation is high. However, that burden is not insurmountable. A prudent contractor would be well advised to follow corporate formalities and make sure that corporate funds are not commingled for personal use.

An “account stated” is an agreement, express or implied, between parties who have prior dealings that a particular sum is due from one to the other. The agreement may be implied, for example, when a contractor sends regular bills or invoices to the owner and the owner keeps them without objecting to the invoices within a reasonable period of time. An objection to the invoices after litigation has been commenced is not made within a reasonable time.

In the recent case of A. & L. Construction Corp. v East Harlem Developers, LLC, the court allowed the contractor to recover monies due from the owner based on an account stated theory of liability.

Background

A&L, a general contractor, entered into a general construction contract with East Harlem, a property owner, to furnish interior framing, insulation and sheetrock. The work commenced in February of 2008 and ended in April of 2010. As the work progressed, A&L submitted periodic invoices to East Harlem, and East Harlem had submitted partial payments in response to some of those invoices. East Harlem never disputed the invoices. Nor did it claim any deficiencies in the work reflected on the invoices.

A&L sued and, ultimately, moved for summary judgment. In support of its motion, A&L noted the work it performed, the invoices it sent to East Harlem, partial payments made by East Harlem, and East Harlem’s failure to object to the invoices. For the first time in opposition to A&L’s summary judgment motion, East Harlem objected to A&L’s invoices and claimed that the work was inferior and defective. East Harlem also sought a counterclaim against A&L based on the claimed defective work.

Decision

The court granted the contractor’s motion for summary judgment, finding that the owner received and retained the contractor’s invoices for the work without making a reasonably timely objection. As for East Harlem’s counterclaim for defective work, the court ruled that East Harlem had not submitted sufficient evidence that it made any objection on that basis or any other basis upon receipt of A&L’s invoices or within a reasonable time thereafter.

Comment

If a series of invoices are sent that are not objected to within a reasonable period of time, they will be regarded as proof that the invoices stated the correct amounts. The debtor has a duty to examine the invoices to ascertain whether they are correct or not. Silence demonstrates that the debtor does not dispute the balance due. An objection to the invoices or a claim of defective work that is first made only after litigation on the account stated theory is not a defense to the account stated. An account stated claim is a useful legal remedy to collect monies due to a contractor, subcontractor or material supplier.

Lien Law Article 3A creates a trust for funds received by an owner over funds that he received on a construction project. The trust fund provisions were enacted in part to protect contractors, subcontractors and suppliers against owners who divert money for purposes other than for payment of labor and materials on the project. For example, an owner can be found liable for diversion of trust funds if he uses the funds received on one project to pay for labor and materials on another project or for non-project purposes. An owner may incur personal liability for diversion of trust funds which cannot be discharged in bankruptcy. The Lien Law trust fund provisions apply similarly to contractors and subcontractors who receive funds on a project.

An owner, as statutory trustee, must keep records of all monies received and distributed on a project. Under Lien Law Section 76, contractors, subcontractors and suppliers, as trust fund beneficiaries, can demand that the owner provide a sworn written statement showing all monies received and expended on the project.

In the case of Matter of Paik Construction, Inc. v Dienst, a court determined whether a contractor is entitled to a verified statement from the owner where there is a pending mediation before the American Arbitration Association and the owner disputes that any monies are owed to the contractor.

Background

Paik Construction was hired by the owners, Jill and Daniel Dienst, to perform certain renovations to their apartment. The form of contract between the Diensts and Paik was an AIA agreement that provided that the parties mediate any disputes before proceeding to litigation. During the course of the project, the relationship between the parties broke down. While the contractor claimed that it was owed $425,000, the owners claimed that nothing was owed as a result of the contractor’s breach of the contract.

The contractor served the owners with a Section 76 demand for a verified statement, demanding that they set forth with specificity each and every payment received into the trust and each and every payment made out of the trust fund. When the owners did not respond, the contractor commenced a court proceeding to compel a response. In addition to several service of process related arguments, the owners argued that the contract between the parties required mediation before the initiation of any litigation, and that the contractor was not entitled to the verified statement or to bring a court proceeding seeking to compel its production until the parties’ completed the mediation required by the contract.

Decision

The court granted the contractor’s petition and directed the owners to comply with the demand for the verified statement. The court held the purpose behind the statute requiring an owner to provide a verified statement is to allow a contractor, as a trust fund beneficiary, to determine whether an owner diverted trust monies for non-trust purposes. The court noted that while the contract did, indeed, provide for mediation of the underlying dispute before litigation, the contractor’s right to the verified statement arises under Article 3A of the Lien Law and, therefore, is independent of the contract. Although the contractual dispute was submitted to mediation, it did not alter the owner’s Lien Law obligation to provide a verified statement.

Comment

A demand for a verified statement or demand for inspection of the owner’s books and records is an effective disclosure device that can be used by unpaid contractors, subcontractors and material suppliers. The right to an accounting is liberally granted by the courts, even if the owner denies that monies are owned to the contractor or there is a separate lawsuit by the contractor for collection of monies owed. It is only fair that job claimants, who have provided the wherewithal that made possible the construction of a project, should have the right to be informed as to whether the owners wrongfully diverted trust funds for the project for non-trust purposes.

Contractors and subcontractors have the right to stop work for nonpayment under the contract. The right to abandon the project for nonpayment is not an absolute right, however. Where a contractor is legally justified in stopping the work depends upon the circumstances.

The factors in deciding whether to stop work are: (1) the amount of the overdue payment; (2) the length of time the payment is overdue; (3) whether there is any legal justification for withholding payment; (4) whether prior contractual notice is required; (5) the amount of work remaining to be performed; and (6) whether there are contract provisions that apply to the situation.

The recent case of Kleinberg Electric, Inc., v E-J Electric Installation Co. demonstrates the pitfalls of stopping work for nonpayment.

Background

Kleinberg Electric was a subcontractor to E-J Electric Installation Co., the general contractor on a project for the New York City Department of Environmental Protection in Queens. The subcontract provided that the owner was the arbiter as to the extent and value of work performed by Kleinberg, and that in the event of a dispute as to whether directed work was extra work or base contract work, Kleinberg was to perform the work promptly. The subcontract also provided that no change orders would be paid unless those change orders were approved in advance.

During the course of the project, Kleinberg was directed to perform certain work relating to the installation of certain cables and conduits. Kleinberg claimed that this was extra work and prepared a change order seeking to be paid for this work. E-J responded by advising Kleinberg that it was authorized to proceed with the work set forth on the change order, and noted that this work would allow Kleinberg to complete its contract work. E-J also required that all of the foregoing work be completed by a certain date. On the specified completion date, Kleinberg was only 50% complete with the claimed change order work. Accordingly, E-J advised Kleinberg that it would perform the remainder of that work with its own forces.

When Kleinberg requested that E-J execute the change order for the above work, E-J responded that no such change order would be forthcoming. Kleinberg then prepared an invoice to bill E-J for the actual work it performed relating to the claimed change order. At the same time, E-J directed Kleinberg to perform certain lighting work. Kleinberg prepared a change order for the work, which E-J refused to sign on the grounds that the work was base contract work.

The problems between E-J and Kleinberg continued to escalate when E-J provided Kleinberg with a list of incomplete work. Kleinberg claimed that these lists were punchlists, and that it was 99% complete with its scope of the work. E-J advised Kleinberg that its work was not complete, contrary to Kleinberg's claims. Kleinberg refused to return to the worksite, despite numerous notices from E-J that if it did not complete its work E-J would be forced to complete Kleinberg's work and back charge Kleinberg for the cost to complete. Ultimately, the owner determined that Kleinberg had completed only 73.49% of its work.

Kleinberg sued E-J to recover both the balance of its contract and the change order work. E-J counterclaimed to recover the cost of completing Kleinberg's work. At trial, Kleinberg argued that E-J breached the contract by failing to pay Kleinberg for the change order work, and that to the extent that there may have been outstanding work, it was justified in suspending performance based on E-J's nonpayment. E-J argued that the contract provided that Kleinberg could not suspend its work in the face of a dispute over an extra work claim, and that its walking off the job while disputing a change order claim was a material breach of the contract.

Decision

The trial court, after noting the general principle that an unpaid contractor may suspend performance when it remains unpaid, stated that the party seeking to suspend performance must nevertheless comport with standards of good faith and fair dealing. The court held that in light of the contractual language which required Kleinberg to continue to perform its work even where it disagreed with E-J as to whether certain work was contract work or extra work, its suspension of work constituted a material breach of the contract for which E-J was entitled to recover its cost to complete damages.

On appeal, the appellate court affirmed the lower court's decision, pointing out that the subcontract provides that time is of the essence, that Kleinberg's delay warrants termination, and that Kleinberg must perform the work even if the parties dispute that work's characterization. The court noted that Kleinberg repeatedly failed to perform and complete the work, despite E-J's repeated demands.

Comment

Contractors are cautioned to proceed carefully before deciding to stop work based on non-payment. While suspension of work may be justified in some circumstances, the contractor must be certain that it has complied with the work stoppage provisions of the contract or else its decision to "walk off the job" may constitute a breach of contract, exposing itself to liability for consequent completion costs.

About the author: Mr. Miuccio is a partner of the law firm of Welby, Brady & Greenblatt, LLP and General Counsel to the Construction Industry Council of Westchester & Hudson Valley, Inc. Gregory J. Spaun, a Partner with the firm, assisted with the preparation of this article.

Lien Law Article 3A creates a trust for funds received by an owner over funds that he received on a construction project. The trust fund provisions were enacted in part to protect contractors, subcontractors and suppliers against owners who divert money for purposes other than for payment of labor and materials on the project. For example, an owner can be found liable for diversion of trust funds if he uses the funds received on one project to pay for labor and materials on another project or for non-project purposes. An owner may incur personal liability for diversion of trust funds which cannot be discharged in bankruptcy. The Lien Law trust fund provisions apply similarly to contractors and subcontractors who receive funds on a project.

An owner, as statutory trustee, must keep records of all monies received and distributed on a project. Under Lien Law Section 76, contractors, subcontractors and suppliers, as trust fund beneficiaries, can demand that the owner provide a sworn written statement showing all monies received and expended on the project.

In the case of Matter of Paik Construction, Inc. v Dienst, a court determined whether a contractor is entitled to a verified statement from the owner where there is a pending mediation before the American Arbitration Association and the owner disputes that any monies are owed to the contractor.

Background

Paik Construction was hired by the owners, Jill and Daniel Dienst, to perform certain renovations to their apartment. The form of contract between the Diensts and Paik was an AIA agreement that provided that the parties mediate any disputes before proceeding to litigation. During the course of the project, the relationship between the parties broke down. While the contractor claimed that it was owed $425,000, the owners claimed that nothing was owed as a result of the contractor’s breach of the contract.

The contractor served the owners with a Section 76 demand for a verified statement, demanding that they set forth with specificity each and every payment received into the trust and each and every payment made out of the trust fund. When the owners did not respond, the contractor commenced a court proceeding to compel a response. In addition to several service of process related arguments, the owners argued that the contract between the parties required mediation before the initiation of any litigation, and that the contractor was not entitled to the verified statement or to bring a court proceeding seeking to compel its production until the parties’ completed the mediation required by the contract.

Decision

The court granted the contractor’s petition and directed the owners to comply with the demand for the verified statement. The court held the purpose behind the statute requiring an owner to provide a verified statement is to allow a contractor, as a trust fund beneficiary, to determine whether an owner diverted trust monies for non-trust purposes. The court noted that while the contract did, indeed, provide for mediation of the underlying dispute before litigation, the contractor’s right to the verified statement arises under Article 3A of the Lien Law and, therefore, is independent of the contract. Although the contractual dispute was submitted to mediation, it did not alter the owner’s Lien Law obligation to provide a verified statement.

Comment

A demand for a verified statement or demand for inspection of the owner’s books and records is an effective disclosure device that can be used by unpaid contractors, subcontractors and material suppliers. The right to an accounting is liberally granted by the courts, even if the owner denies that monies are owned to the contractor or there is a separate lawsuit by the contractor for collection of monies owed. It is only fair that job claimants, who have provided the wherewithal that made possible the construction of a project, should have the right to be informed as to whether the owners wrongfully diverted trust funds for the project for non-trust purposes.