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(A revised version of this article appears in The Construction
Lawyer, Volume 22, No. 2, Spring 2002, published by
the American Bar Association's Forum on the Construction
Industry.)
By John W. Ralls
The
City of Brookings, South Dakota, hired the low bidder to
construct an exhibition hall and research building. During
construction, the city issued two significant change orders:
(1) A $107,000 change order for paving a parking
lot originally scheduled to be gravel and (2) A $441,000
change order for tenant improvements of a portion of the
building originally scheduled to be left unimproved. The
two change orders were negotiated, not competitively bid.
The
contractor inquired about the propriety of proceeding with
the change orders without competitive bidding. The City
Attorney opined that the change orders were permissible
because the changes were precipitated by unforeseen circumstances
necessary to the completion of the project. When the legality
of the change orders was questioned by a taxpayer and found
to be unlawful by a state auditor, the city adopted an ordinance
allowing it to proceed even if the change orders were later
found unlawful by a court.
The
taxpayer sued the city and the contractor to have the change
orders declared void and to have any payments to the contractor
refunded. The trial court granted summary judgment in favor
of the taxpayer and ordered that the contractor refund all
amounts paid on the invalid change orders. The South Dakota
Supreme Court affirmed in part and reversed in part. Bozied
v. City of Brookings, 2001 S.D. 150, 638 N.W.2d 264
(2001). There were three parts to the court's opinion.
First,
the Supreme Court found that the ordinance purporting to
legalize the change orders was invalid. The city defended
the ordinance on the ground it held a home rule charter
that, under the South Dakota Constitution, permitted the
city to "exercise any legislative power or perform
any function not denied by its charter, the constitution
or the general laws of the State." South Dakota Constitution,
Article IX, §2. The South Dakota Supreme Court rejected
this argument because home rule powers may not be exercised
to establish standards or requirements that are lower or
less stringent than those imposed by state law. Moreover,
South Dakota Constitution Article XII, §3 provides
that even the Legislature may not authorize payment of claims
made under void contracts. The court also concluded that
even if the ordinance were valid, it could not retroactively
validate void contracts.
Second,
the court considered whether the change orders should have
been competitively bid. At the time the change orders were
negotiated, South Dakota Codified Law §5-18-18.3 provided:
Any
amendment or change order to an existing construction
contract need not be bid if the contract contains unit
prices for the same type or class of work, or the change
or extra work is necessitated by circumstances not reasonably
foreseeable at the time the underlying contract was let
and the change or extra work is necessary to the completion
of the project.
The
South Dakota Legislature later amended SDCL §5-18-18.3
to limit the "reasonably foreseeable" exception
to situations where the "change or extra work is necessitated
by circumstances related to soils, utilities, or unknown
conditions directly affecting the performance of the work…."
The court applied the older version of the statute, which
was in effect at the time the change orders were issued.
The
contractor argued that what was "reasonably foreseeable"
and what was "necessary" to complete the project
were questions of fact. The contractor claimed that it was
necessary to pave the parking lot and build out the space
to accommodate new tenants, which had signed leases and
wanted to move in sooner than had been reasonably foreseen.
The court agreed that the issues could not be resolved by
summary judgment and remanded the case for trial of those
issues.
Third,
the court grappled with what it said was the "crux
of our case," whether the contractor was required to
refund payments in the event the trier of fact found the
change orders to be invalid. On the one hand, the court
said that a harsh and inflexible rule that requires contractors
to return money paid for a void contract promotes government
integrity and public protection. On the other hand, the
court said that such a rule may unfairly punish a contractor
who performs in good faith and may unjustly enrich the public
entity. After reviewing decisions from other states, the
court found that "several courts faced with this situation
have allowed a contractor to retain funds already paid but
not to recover additional funds." The court concluded,
"A contractor who fully performs a contract of this
character and then receives payment should not be compelled
to refund the money." In such situations, the courts
should leave the parties where it finds them.
The
taxpayer alleged that the city and the contractor had colluded.
The taxpayer pointed to the fact that the contractor's principal
had served on a design committee for the project and to
the fact that the City Attorney was a law partner of the
contractor's attorney. The court found the charges to be
serious but unproven. "In the event the change orders
are found to violate th[e] statute, the contractor may nonetheless
retain all payments received in the absence of proof of
fraud, collusion, or undue influence."
A
dissenting justice argued that the change orders were void
as a matter of law. The justice pointed out that the city
foresaw the need to construct the tenant improvements and
to pave the parking lot and that neither of these changes
were necessary to the completion of the project that was
let out to bid. "If City and [contractor] knew that
these changes were going to be made at some point in the
future, they were not unexpected and were reasonably foreseeable
at the time the underlying contract was let." The dissenting
justice also argued that the appropriate remedy for a void
public contract was refund of the monies paid to the contractor.
"The forfeiture of all the money paid under the illegal
change orders may seem harsh in this instance; but I believe
the remedy to the taxpayers is appropriate if the public
bidding laws of the State of South Dakota are to have any
real meaning in the future."
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