Construction contracts are usually formed by signing contract documents. The signature is a manifestation of assent to be bound by the terms of the contract. Contracts can also be formed orally, and by conduct.

Although oral contracts are enforced by the courts, it is risky to rely on them because it may be difficult to prove mutual assent to the terms of an oral contract. A contractor’s course of conduct may signify an intent to be bound to the obligations of a contract.

In the recent case of Minelli Construction Co., Inc. v. Volmar Construction, Inc., an appellate court held that a contractor’s course of conduct constituted acceptance of a subcontractor’s offer to perform the work for a fixed price.

Background 

Volmar Construction, Inc. was the general contractor on a project to renovate a school for the New York City School Construction Authority. Minelli Construction Company, Inc. was a masonry subcontractor at the project. During construction, the need for additional masonry work became apparent and the subcontractor submitted a written offer to perform the work for $498,000. In response, the contractor issued a letter of intent to enter into a subcontract for the $498,000. The letter of intent was expressly contingent upon approval of the subcontractor’s proposal by the SCA.

Though the subcontractor’s price was comparable to the SCA’s own cost estimate for the work, the SCA tried to negotiate the price for the work. The subcontractor refused, stating in writing on several occasions that the $498,000 was non-negotiable and was the amount the subcontractor needed to perform the work. Discussions between the contractor and the SCA broke down, and, without the SCA having approved the subcontractor’s proposal, the contractor directed the subcontractor to perform the work.

The subcontractor performed the work. The contractor did not object the subcontractor’s first payment requisition, which stated a contract price of $498,000. The contractor also filed a notice of claim with the SCA to recover the sum of $498,000 for the subcontractor’s work, which amount the contractor described in a sworn affidavit as the “fair and reasonable value” of the work.

After the work was complete, the contractor refused to pay any portion of the $498,000 on the grounds that the letter of intent expressly conditioned payment on the SCA’s approval of the subcontract for $498,000. The subcontractor sued the general contractor and moved for summary judgment. The trial court ruled in favor of the subcontractor and the general contractor appealed.

Decision

The appellate court upheld the award of summary judgment in favor of the subcontractor. The court stated that, under these circumstances, the letter of intent did not constitute a binding contract, but was merely an unenforceable agreement to agree.

The court held, however, that the general contractor’s direction to the subcontractor to perform the work constituted an objective manifestation of assent to the subcontractor’s quoted price. The court also stated that the general contractor’s failure to object to the subcontractor’s first payment requisition, and the general contractor’s submission of a claim to the SCA for the $498,000, presented further evidence that the general contractor agreed to the price term.

Comment

Letters of intent are frequently issued by a contractor in an attempt to get a subcontractor working on a particular project, prior to the execution of a formal contract. The letter of intent usually attempts to condition any obligation of the general contractor upon the execution of a written contract. Here, the court refused to permit a contractor to, on the one hand, direct work, but on the other hand, rely on a provision in the letter of intent to avoid paying the subcontractor. Though the court ultimately sided with the subcontractor, the prudent contractor should make every effort to enter into a written agreement prior to performing work.

Public construction contracts are subject to New York’s competitive bidding statutes. They provide that the contract shall be awarded to the lowest responsible and responsive bidder.

A “responsible” bidder is a contractor who has the skill, integrity, experience, financial and technical resources to complete the work in a satisfactory manner. A “responsive” bidder is a contractor who has complied with the exact requirements of the bid invitation. In the recent case of Matter of E&A Restoration, Inc. v. Town of North Hempstead, the court determined whether there was a rational basis for the Town’s rejection of a bidder as non-responsible. 

Background 

In May 2010 the Town of North Hempstead solicited bids for the construction of the North Hempstead Community Center. The Town’s bid documents advised prospective bidders that the community center was to be a 60,000 square foot building, certified as platinum under the United States Green Building Council’s (USGBC) Leadership in Energy & Environmental Design (LEED) rating system. The bid documents further advised prospective bidders that the Town would not accept bids from, nor award a contract to, anyone who could not prove to the satisfaction of the Town Board that they had sufficient experience and financial stability to complete the project as designed on time and on budget.

The technical requirements outlined in the project bid documents required the responsive contractors to demonstrate the completion of five similar projects, experience and expertise with the LEED rating system, and that a LEED accredited professional would be engaged to coordinate the LEED requirements of the project. The bid documents also noted that substantial Federal, State and local government grant money was contingent upon the project obtaining LEED platinum certification. 

A number of bids were received in response to the Town’s solicitation, including bids from E&A Restoration, Inc., the second lowest bidder, and Racanelli Construction Co., Inc., the fifth lowest bidder. In reviewing the bids, the Town determined that the first four lowest bidders either had no, or very little, of the required experience. Accordingly, the Town awarded the contract to Racanelli. In response, E&A Restoration sued, looking to have the contract award annulled. 

Decision

The court ruled in favor of the Town. In upholding the contract award, the court relied upon well-established case law, noting that the requirement of awarding public work to the lowest responsible bidder involves considerations of skill, judgment and integrity. The court noted that a municipality may investigate the experience and background of the bidder, and where good reason exists, the low bid may be disapproved or, indeed, all the bids rejected. The court also noted that where a municipality exercises its discretion to reject one or more bids, that decision ought not to be disturbed by the courts unless it is irrational, dishonest or otherwise unlawful.

After E&A Restoration submitted its bid, its staff members were enrolled in a LEED certification class, but were not yet LEED accredited professionals. In addition, E&A had not yet completed a project of similar nature, scope, cost or complexity.

In contrast, Racanelli demonstrated that it had completed five similar projects, including serving as the single-prime general contractor on a $100 million three campus project. The company also employed LEED accredited professionals and worked on LEED certified projects. Since the court determined that the Town’s decision to award the contract to Racanelli, as the experienced contractor, was rational, and there was no evidence to suggest that the award was dishonest, the court denied and dismissed E&A Restoration’s lawsuit. 

Comment 

This case confirms the importance of contractors remaining familiar with industry trends so as to remain commercially competitive. Here, a number of bidders encountered difficulty demonstrating experience and familiarity with the LEED rating system, which has dramatically grown in popularity among owners in recent years. The Town’s bid documents made clear that it was seeking bids from contractors who were not only experienced with projects of this size, but also the LEED rating system. Since experience is a prime consideration when determining whether a bidder is responsible, the Town was entitled to award the contract to the lowest responsible contractor experienced with the type of project involved.

Disputes between contractors and subcontractors may ultimately require recourse to the courts.  A trial judge will allow both sides to present witnesses and produce documents as to the issues in dispute.  The judge will then make credibility determinations, resolve factual disputes and grant judgment upon application of the appropriate legal standard.

At times, however, a judge may grant summary judgment without a trial where the affidavits and supporting documents demonstrate the absence of factual disputes.  In the recent case of Durao Concrete, Inc. v. RJD Construction, Inc., a subcontractor was able to convince the court that it should enter summary judgment in its favor.

Background 

RJD Construction, Inc. was hired as a general contractor in connection with a construction project located in Yaphank, New York.  Under its agreement with the owner, RJD was to be paid $591,375.  RJD subcontracted the installation of a concrete foundation, footings, walls and slabs to Durao Concrete, Inc. for the agreed price of $40,000.  The subcontractor completed its work in August 2007 and submitted invoices to the general contractor totaling $41,800.  The additional $1,800 was for the use of a pump truck to pump the cement to the job.  After the general contractor failed to pay the subcontractor’s invoices, the subcontractor filed a mechanic’s lien, sued the general contractor, and moved for summary judgment.

In opposition to the subcontractor’s motion for summary judgment, the general contractor argued that the subcontractor’s work was not properly performed, which led to cracks in the concrete.  The contractor also argued that since the parties’ agreement was for $40,000 it was not required to pay the subcontractor the $41,800 billed for the completed work. The contractor also claimed that the debt due to the subcontractor had been consolidated with monies due on other projects, which were settled and paid.  However, the contractor did not indicate the amount of the settlement, or how or when it was paid.  According to the general contractor, proof of the settlement and payment had been lost in a flood.

In response, the subcontractor submitted evidence that the owner had paid the general contractor in full for the subcontractor’s work, that the general contractor never complained of the quality of the subcontractor’s work until after the lawsuit was commenced, that only $40,000 was being claimed as due in the lawsuit, that no such settlement or payment ever occurred, and that the subcontractor was entitled to be paid as agreed for the work performed and completed.

Decision

The court granted summary judgment in favor of the subcontractor as to liability and directed a trial as to the amount of money actually due to the subcontractor.  According to the court, the subcontractor established that the general contractor agreed to pay the subcontractor $40,000 for its work at the project; the subcontractor performed its work at the project in accordance with its initial proposal and estimate; the general contractor received payment in full from the owner; and the general contractor failed to pay the subcontractor any monies with respect to the work performed.

As to the general contractor’s claim that the parties had agreed to settle the debt due to the subcontractor together with the debt owed on other jobs, the court noted that the alleged settlement payment was by check, and notwithstanding the alleged flood, the general contractor could have obtained duplicate records from its banking institution, which the general contractor failed to do.  Under these circumstances, the court determined that the grant of summary judgment in favor of the subcontractor was appropriate.

Comment 

It is difficult to persuade a court to grant summary judgment without a trial because in most cases credibility questions require a trial.  Here, however, the general contractor failed to produce any documents to justify his refusal to make payment to the subcontractor.  If there is no material factual dispute to decide, why have a trial?  It was therefore appropriate for the court to grant summary judgment to the subcontractor.

There are few projects completed with no changes or additions to the original contract.  Problems arise when the contractor fails to comply with the standard contract requirement for changes and extras to be in writing.

Equally problematic for contractors is the common contract clause providing for “no damage-for-delay”, which precludes delay claims by contractor.

In the recent case of ADC Contracting & Construction, Inc. v. Town of Southampton, the court ruled on the enforceability of contract provisions requiring written approval for change orders and extra work and the “no-damage-for-delay” clause.

Background 

ADC Contracting & Construction, Inc. contracted with the Town of Southampton, New York to construct an animal shelter.  According to the contractor, the Town directed, and the contractor performed, extra work for which a written change order was never issued. 

The contractor also claimed that the Town delayed the project by poor planning and scheduling.  The Town acted as its own general contractor and entered into separate contracts with ADC, as the construction contractor, a plumbing contractor and an electric contractor.  The contractor argued that the Town’s inexperienced representatives failed to supervise and coordinate the various trades, which resulted in interference and hindrance in the contractor’s ability to orderly and efficiently perform under the contract.  The lack of supervision and coordination resulted in delays, as well as additional work, which increased the cost of the contract.

When the Town refused to pay for the extra work and the contractor’s delay claim, the contractor sued.  The Town moved for summary judgment, arguing that the parties’ contract required all change orders and extras to be in writing, and that the contract barred the contractor’s recovery of any delay damages.

Decision

The court dismissed the contractor’s delay claims, but permitted the contractor’s extra work claims to proceed to trial.  In making its decision, the court relied on the express terms of the parties’ agreement and the controlling case law.  With regard to the contractor’s delay claim, the court noted that the contract stated: “Where Contractor is prevented from completing work due to a delay beyond his control, an extension of the time to complete the specific task shall be Contractor’s sole and exclusive remedy for such a delay.”  The court went on to state that notwithstanding the owner’s poor planning and scheduling, inept administration of the project was within the scope of the no-damages-for-delay clause.  Accordingly, the court dismissed the contractor’s delay claims, ruling that an extension of time to complete the work was the contractor’s only remedy for project delays caused by the owner.

As for the contractor’s extra work claim, the court referred to contract provisions requiring all changes to be first approved in writing.  However, the court also pointed to case law which prohibited an owner from relying on such a provision to avoid payment if the absence of a written approval was caused by the owner. 

The contractor submitted written correspondence with the owner and testimony from the Town’s representatives at their examinations before trial to raise factual questions as to whether the Town had actual knowledge of the contractor’s additional work claims and whether the Town, through the conduct of its agents, waived its right to insist upon strict compliance with the requirement of written authorization.  Since the court was uncertain as to whether the absence of a written extra was caused by the owner, the court permitted the contractor’s extra work claims to remain.

Comment 

Though there are limited exceptions, no-damages-for-delay contract clauses are frequently upheld and enforced by New York courts.  Contract clauses that require extra work to be performed pursuant to a written change order prior to triggering an owner’s payment obligations produce differing results from the courts.  On one hand, courts are sometimes hesitant to deny a contractor compensation for work verbally directed by the owner.  On the other hand, courts may strictly enforce the requirement of a written authorization.  The particular facts of a case will determine whether a court will allow a waiver of the written change order requirement.  A prudent contractor should insist upon written approval before performing changes or extras, rather than risk a court’s enforcement of a contract requirement of a written authorization.

Claims by contractors for extra work continue to be a major source of construction litigation.  There are few projects completed with no additions or changes to the original contract.  Most contracts have a standard provision requiring that orders for extra work be in writing.  Problems arise when the contractor does not obtain the approval for the extra work but proceeds to perform the additional work anyway.

In the recent case of Tadco Construction Corp. v. Dormitory Authority of the State of New York, the court ruled on the contractor’s extra work claims.

Background 

TADCO Construction Corp. entered into a written contract with the Dormitory Authority of the State of New York to perform certain work related to the marina rehabilitation project located at Kingsborough Community College. Under the parties’ agreement, the contractor agreed to perform all work and furnish all supplies and materials for the price of $1,436,642, subject to adjustments for extra work or alterations to or deductions from the work. 

Before construction started, the contractor determined that fixing the floating dock system would only extend the life of the dock by a few years, and that replacing the dock, although more expensive, would give the dock a significantly longer lifespan.  The contractor presented this information to DASNY, who responded that it would not entertain an increase in costs for the repair of the dock, and that it would only approve replacement of the dock if it did not increase the contract price.  The contractor responded by telling DASNY that it intended to proceed with its plan to replace the dock “under protest” and that it would seek compensation for the increased costs of this plan later, by submitting a change order request.

When the contractor submitted the change order request for the cost of the replacement dock in the amount of $155,040, DASNY refused to pay it, arguing that the contractor had chosen to replace the dock system on its own initiative and that DASNY had repeatedly told the contractor that it would not approve a change in contract price if the contractor chose to proceed with the installation of the new dock system.  Based on DASNY’s denial of the change order request, the contractor filed suit, seeking to recover the extra costs related to the replacement dock.  DASNY responded with a motion for summary judgment, seeking to have the contractor’s extra work claims dismissed.

Decision

The court ruled in favor of DASNY, denying the contractor’s extra work claims.  According to the court, recovery cannot be had for “extra” work which actually falls within the contract or the plans and specifications, but recovery may be had for work outside the contract where the contractor was in fact specifically ordered to do work that was not within the scope of that called for by the contract. 

Here, the court ruled that the contractor chose to proceed with the dock replacement plan after being told by DASNY that it would not agree to any changes in the original contract plan that would result in increased costs.  Because the work was not ordered by DASNY, the court determined that the contractor voluntarily substituted materials in the project at its own discretion, and the costs of that choice are not recoverable.  Accordingly, the court granted summary judgment in favor of DASNY.

Comment 

A contractor who wishes to be assured that he will be paid for extra work should follow the contractual requirements and obtain proper written authorization to do the additional work either from the owner or his duly authorized representative prior to performing the extra work.  As this case demonstrates, a contractor should not ignore contract provisions relating to extra work in the hope that a court may make an exception to the contract and find a waiver under particular facts and circumstances.

Failure of a contractor to carefully comply with all the requirements of the bid specifications for public works may result in the bid being rejected on the grounds of “non-responsiveness”.  A bidder may be allowed to correct his mistake after the bid opening, however, if the variance from bid specifications is not material.  For example, clerical errors or mere irregularities may be waived by the awarding authority.

The contracting agency, however, should not allow a bidder to correct its bid after the bid opening in a way that would give the bidder a substantial advantage or benefit not enjoyed by the other bidders.  When essential information is missing from a bid, it may not be supplied later by a private understanding between the bidder and the awarding authority.

In the recent case of Metra Industries Corp. v. Rockland County Sewer District No. 1, the court ruled on whether the County’s decision to allow a bidder to correct its mistake after the bid opening gave the bidder an advantage over the other bidders, thereby undermining the open competitive bidding process.

Background 

In June of 2010 Rockland County invited bids for a project to extend and replace the North Pascack Sewer Interceptor.  Among the bid specifications was a requirement that the total value for Mobilization/Demobilization could not exceed five percent of the total contract award.  All bids were submitted by the July 8, 2010 deadline.  Montana Construction Corp., Inc. had the lowest bid, which was $2,712,319.  Metra Industries Corporation submitted the second lowest bid, which was $2,903,214.  Montana’s low bid contained a Mobilization/Demobilization price of $250,000, which exceeded the five percent limit set forth in the bid specifications.  Unknown to Metra, after the County advised Montana of the defect in its bid, Montana lowered its Mobilization/Demobilization cost from $250,000 to $129,000, reducing their total initial bid by $121,000.  Once the bid was reduced, Montana’s bid totaled $2,591,320, approximately $311,894 less than Metra’s bid.  According to Montana, the initial figure of $250,000 was essentially a clerical error caused by the inadvertent combination of a separate cost item with the Mobilization/Demobilization price. 

On July 9, 2010 Metra sent a letter to the County complaining that Montana’s bid was defective since Montana’s Mobilization/Demobilization cost of $250,000 exceeded the five percent limitation in the bid specifications.  On July 16th, the County sent a letter in reply, acknowledging the bid defect, but went on to state that Montana’s bid had been adjusted to comply with the specifications, and that the County would approve Montana’s bid.  Metra sued to stop the County from awarding the job to Montana, arguing that allowing Montana to correct its mistake after the bid opening placed Montana at a competitive advantage over the other bidders.

Decision

The court ruled in favor of the County.  According to the court, immaterial bid errors in a bid can be waived by a municipality, so long as the municipality has a rational basis for its determination.  In determining whether a bid error is or is not material, the court looked to the effect of the waiver and whether other bidders will be placed at a competitive disadvantage.  According to the court, if the waiver of the error by the municipality promotes completion of the work as specified without placing other bidders at a competitive disadvantage, the error may be deemed immaterial and can be waived.

Here, the court noted that the effect of the waiver, and Montana’s subsequent lowering of its bid, ensured that the contract would be entered into, and the same work performed, at a lower price than initially bid.  Since it was in the County’s best interest to waive the bid defect and permit correction, the court held that a rational basis existed for the County’s determination.  Also, the court pointed out that the County’s waiver of the defect did not place Montana at a competitive advantage since Montana was the lowest bidder with or without the error.  Accordingly, the court permitted the County to move forward with awarding the contract to Montana.

Comment 

There is no conclusive formula for determining on a case-by-case basis what constitutes a substantial bid defect as opposed to a minor defect.  The courts give broad discretion to public authorities in determining whether a bid is responsive and will uphold the agency’s determination if supported by a rational basis.

A disappointed bidder on a public project can go to court and challenge an award to the lowest bidder if he believes that the successful bidder failed to comply with the bid documents.  Although minor defects or irregularities in a bid may be waived by the contracting authority, a failure to conform to a material or substantial bid requirement cannot be waived or corrected after the bid opening.

In the recent case of Gemstar Constr. Corp. v. County of Nassau, the issue before the court was whether a low bidder’s variance from the bid specifications gave him an unfair advantage or benefit not enjoyed by the other bidders.

Background 

In July 2009 the Nassau County Department of Public works invited bid proposals for two public improvement contracts relating to the removal and replacement of underground storage tanks at the Rockville Centre and Garden City MTA Long Island Bus maintenance depots.  The instructions to bidders required that the bids include a verification that the bidder had an approved State of New York registered Apprenticeship Training Program.  TCM Services, Inc. and Environmental Closures, Inc. were the lowest bidders for the two projects.  However, only the next lowest bidder for each job, Gemstar Construction Corp., had an approved registered New York State apprenticeship program when the bids were opened.  The low bidder, TMC, produced a verification of a New York State apprenticeship program twenty-four days after the bid opening.  The other low bidder, Environmental Closures, submitted its verification of a New York State apprenticeship program fifty-one days after the bid opening. 

Gemstar protested the awarding of the bids to TCM and Environmental Closures on the grounds that they failed to timely comply with the bid specifications.  The County denied Gemstar’s protest and Gemstar petitioned the court to reverse and annul the County’s determination.

Decision

The court reversed and annulled the County’s award and directed that the bidding be reopened.  The court stated that a governmental agency has the right to determine whether a variance from bid specifications is substantial or whether to waive it as a mere irregularity, and that determination must be upheld by the courts if supported by any rational basis.  However, the court also noted that a contracting agency may not allow a bidder to correct its bid after the bid opening in a way that would result in an unfair competitive advantage over the other bidders.  According to the court, TMC and Environmental Closures did not provide verification of the apprentice program mandated by the bid requirements until long after the bid opening and, as a result, “gained a competitive advantage” over Gemstar. 

The responsiveness of a bid must be assessed on the face of the bid at the time the bids are opened.  TMC and Environmental Closures should not have been allowed to submit their apprenticeship information long after the opening of bids.  This material defect in the bid may not be waived and the County must reject the bid so that all bidders may be treated alike and so that the possibility of fraud, corruption or favoritism is avoided.

Comment 

It is rare for courts to overturn governmental agency determinations of responsive bids.  A contracting agency has the right to determine whether a variance from bid specifications is substantial or whether to waive it as a mere irregularity or minor defect.  However, if it can be shown that the successful low bidder’s variance from the bid requirements gave him an unfair advantage over other bidders, courts will reject the lowest bid. 

Courts impose liability on related companies under the “alter ego” theory where two apparently separate companies are considered to be one, in spite the maintenance of two or more distinct operations.  In other words, the two separate companies are treated as an alter ego of each other for liability purposes.
Under certain circumstances, courts apply the concept of “piercing the corporate veil” to hold corporate owners personally liable for corporate debts.

In the recent case of Matter of B.R.M. Concrete, Inc. v. Portland Transit-Mix, Inc., the court addressed issues of alter ego and the personal liability of a corporate president and sole shareholder.

Background 

B.R.M. Concrete Inc. supplied concrete valued at $193,928 to Portland Transit-Mix, Inc.  When Portland refused to pay for the concrete, B.R.M. sued Portland, its corporate principals, and Bedrock Concrete Inc., which was another company owned by the same principals.

According to B.R.M., Portland and Bedrock failed to follow corporate formalities such that they were mere alter egos of the corporate principals.  Specifically, B.R.M. pointed to the follow factors: (a) there was an overlap in the corporate officers and shareholders; (b) the corporations had the same address; (c) the corporations banked at the same location; (d) the companies held no meetings; (e) the companies had no by-laws; (f) the companies had no records of meetings or documents regarding shareholders; and (g) the companies had no records of business transactions or other financial records.  In addition, Bedrock admitted that it paid for at least a portion of the concrete that was delivered to Portland.  Given defendants’ failure to follow corporate formalities, B.R.M. argued that the corporate and individual defendants were liable for the $193,928 owed.

Defendants argued that only Portland was liable for the debt, which it did not have sufficient assets to pay.  According to defendants, Portland and Bedrock were separate corporations which conducted separate businesses and maintained separate bank accounts.  Defendants also argued that the individual defendants only conducted business on behalf of the corporate defendants.  The defendants moved for summary judgment, seeking to have the claims against the corporate principals and Bedrock dismissed.

Decision

The trial court denied the defendants motion to dismiss B.R.M.’s claims.  According to the court, piercing the corporate veil requires a showing that the individual defendants (1) exercised complete dominion and control over the corporation, and (2) used such dominion and control to commit a fraud or wrong against the plaintiff which resulted in injury.  The mere claim that the corporations were completely dominated by the individual defendants, or conclusory assertions that the corporations acted as their alter ego, without more, will not suffice to support the equitable relief of piercing the corporate veil.  Since the decision whether to pierce the corporate veil, or treat two companies as alter egos in a given circumstance depends on the particular facts and circumstances, the court held that triable issues of fact existed as to whether the corporate principals and Bedrock could be found liable.

Comment 

The analysis of whether corporate principals or corporate entities can be held liable for the debts of another corporate entity under the theories of alter ego or “piercing the corporate veil” requires a fact intensive review.  Here, the court believed that a trial was necessary to determine whether all defendants should be held liable for the debt due.  The prudent contractor should take care to follow corporate formalities so as to minimize the risk of alter ego liability or personal liability resulting from corporate dealings.

Courts will not enforce a contract where there is no “meeting of the minds” between the parties on a material term of the agreement.  There is no contract where one party reasonably understands a contract term to mean one thing and the other party reasonably understands it differently.

In Gessin Electrical Contractors, Inc. v. 95 Wall Associates, LLC, the contractor and the owner had a different understanding of the material terms of their agreement.

Background 

Gessin Electrical Contractors, Inc., a subcontractor, brought a claim for approximately $1.7 million in change orders against the project owner, 95 Wall Associates, LLC.  The parties agreed to resolve the dispute by having the owner pay the subcontractor $500,000.  A settlement agreement was drafted and signed by both the owner and subcontractor. 

At the time that the settlement agreement was entered into, the owner did not realize that approximately $1.1 million of the subcontractor’s claim had already been satisfied by payments from the general contractor to the subcontractor.  Therefore, while the owner thought it was settling the full $1.7 million claim for $500,000, the contractor thought it was settling a $580,000 balance for $500,000.  The parties were not represented by counsel at the settlement meeting.

Only after the owner had paid the first $450,000 required under the settlement agreement did the owner realize that about $1.09 million of the subcontractor’s claim had already been satisfied by payments from the general contractor.  The owner then refused to make any further payments under the settlement agreement and made an overpayment claim against the subcontractor.  The subcontractor sued to enforce the settlement agreement and the owner counterclaimed on account of the overpayment.  Both parties moved for summary judgment.

The motion court found that there was no “meeting of the minds” between the parties, and declared the settlement agreement null and void.  The subcontractor appealed.

Decision

The appellate court affirmed the lower court’s decision.  According to the court, the ultimate aim in interpreting an agreement is to realize the parties’ reasonable expectations through a practical interpretation of the contract language.  Even if parties intend to be bound by a contract, it is unenforceable if there is no meeting of the minds, i.e., if the parties understand the contract’s material terms differently.  Additionally, the court noted that a contract can be rescinded if the failure to do so would unjustly enrich one party at the other’s expense, and the parties can be returned to the status quo ante without prejudice. 

Since the court found that the parties did not have a meeting of the minds with respect to the payment terms of the agreement, and the enforcement of the agreement would have unjustly enriched the subcontractor, the appellate court held that the settlement agreement should be rescinded, restoring the parties to the status quo ante.

Comment 

A “meeting of the minds” is essential to the enforcement of a contract.  As shown in this case, even if parties intend to be bound by a contract, it may still be unenforceable if there is a mutual misunderstanding about a material term.  Here, the parties’ agreement did not reflect either party’s understanding.  The contract will be held unenforceable only if there is a reasonable basis for the parties’ difference of opinion as to what the contract included or did not include.  A party, however, may not create ambiguity in otherwise clear language simply by urging a different interpretation or understanding of the contract wording.  The prudent contractor should make every effort to ensure that clear and unequivocal wording exists in its written agreements.

Flow-down clauses are common in construction contracts. It is often used in subcontracts. A flow-down clause incorporates by reference the terms of the prime contract into the subcontract. It binds a subcontractor to the terms of the prime contract between the owner and the general or prime contractor. 

Courts, however, are reluctant to enforce flow-down provisions against subcontractors because they are at times overly broad or are inconsistent with the terms of the subcontract.

In the recent case of In re Wonder Works Construction Corp. v. R. C. Dolner, Inc., the appellate court ruled on the enforceability of a flow-down arbitration provision against a subcontractor. 

Background 

217 Mulberry Street Company, LLC, as project owner, sought to arbitrate a claim against the general contractor, R.C. Dolner, Inc., for damages resulting from deficiencies in the construction performed pursuant to the prime contract. The prime contract contained an arbitration agreement. The general contractor in turn demanded that the subcontractor who performed the disputed work, Wonder Works Construction Corp., join in the arbitration.

The subcontract stated that with respect to the work, the subcontractor agreed to be bound by every term and provision of the contract documents. The contract documents were defined to include the prime contract between the general contractor and owner. The subcontract also required the subcontractor to assume toward the general contractor all of the duties that the general contractor had assumed towards the owner with respect to the subcontractor’s work. 

Based on the “flow-down” language of the subcontract, the general contractor named the subcontractor as a party to the arbitration. The subcontractor argued that it never agreed to arbitrate its disputes with the general contractor. When the general contractor would not voluntarily discontinue the arbitration, the subcontractor went to court, seeking a ruling that it was not obligated to participate in the arbitration between the owner and the general contractor. 

The trial court ruled in favor of the general contractor, directing the subcontractor and general contractor to proceed to arbitration. The subcontractor appealed. 

Decision

The appellate court reversed and held that the subcontractor was not required to be joined in the arbitration between the owner and the general contactor. According to the appellate court, an alternative dispute resolution agreement, like an arbitration agreement, must be clear, explicit and unequivocal and must not depend upon implication or subtlety. Under New York law, incorporation by reference clauses in a construction subcontract bind a subcontractor only as to prime contract provisions relating to the scope, quality, character and manner of the work to be performed by the subcontractor. 

Since the subcontract lacked an express and specific agreement to arbitrate, the appellate court held that the subcontractor did not waive its right to ordinary judicial process, which includes the use of the court system to resolve disputes.

Comment 

“Ordinary judicial process”, or the use of the courts, is considered a “right” that is not readily waived. As shown in this case, flow-down clauses will bind a subcontractor to prime contract provisions relating to the scope, quality, character and manner of the work to be performed by the subcontractor. However, flow-down provisions will not necessarily bind a subcontractor to other terms agreed to between the owner and general contractor, such as an agreement to arbitrate. The prudent contractor should be aware of this distinction when negotiating flow-down provisions.