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Following is the third of an occasional series of case
studies by James Acret, well-known author of books on construction
law. The case studies will examine issues that can arise
on construction projects.
By James E. Acret
For
15 years Stu Parker worked for a contracting company founded
by his father. Then the family came to a reluctant decision:
Stu should go out on his own. He had no trouble getting
a contractor's license. He could easily show the requisite
experience. Although he only had a high school education,
he had worked his way up from apprentice carpenter to chief
estimator and then vice president in charge of field work.
He was a little rusty on some parts of OSHA, labor law,
and the mechanic's lien law, but he brushed up on those
subjects and passed the exam offered by the Contractors
State License Board with flying colors. He posted his bond
(California Business and Professions Code §7071.6)
and his worker's compensation insurance certificate (§7125)
and became the proud possessor of a California contractor's
license Class B (general building contractor) (§7057).
A
contractor friend offered Stu an opportunity to roof a shopping
center that already was under construction. Stu was qualified
to put the roof on, all right, and he could do it at a fair
price, but he turned down the job because his Class B license
wouldn't cover roofing unless he also was doing at least
one other unrelated trade (§7057). In order to legally
take a contract for roofing work only, Stu would have needed
a C-39 (roofing) license (16 California Code of Regulations
§832.39) and he didn't have one.
A
better prospect for work was offered by Nicholas Keiko.
Nick had graduated from Purdue with a degree in engineering
and an MBA. An avid hockey fan, Nick had been romancing
a group of NHL players who needed an investment outlet for
their ridiculously high salaries. Nick would provide this
outlet in the form of limited partnership interests in a
700-unit apartment project that would be built in one of
the nearby valleys. Nick knew Stu's dad and was looking
for a contractor.
Nick,
a smart, ruthless young guy, had learned a lot about finance
and real estate but didn't know much about construction.
He decided to put his faith and confidence in Stu.
Nick
optioned the land, hired an architect and worked out his
financial projections. On paper it was a good-looking project.
The NHL players were enthusiastic. They felt that they were
doing the responsible thing: making a wise investment.
To
Nick, time was money. All the money that would pour into
the land, the plans, the permits, the construction, taxes,
insurance, marketing and everything else would be totally
unproductive until the first rent check came in. Nick pushed
the architect mercilessly, and he showed a special interest
in the critical path network (scheduling by computer) that
Stu was putting together.
As
recommended by the architect, Nick utilized the AIA contract
forms in setting up the construction contract with Stu's
newly formed corporation. He agreed to pay a substantial
bonus for early completion. As far as Nick was concerned,
time was of the essence.
Stu
"hit the ground running" as Nick had urged him
to do. The project got off to a fast start as soon as permits
were issued. Stu decided to do the framing work with his
own forces: He knew how to swing a hammer and had spent
quite a few years running framing crews.
He
subcontracted the concrete work to the low bidder, Patrick
Mahoney of Mahoney Concrete. This is where the trouble started.
The foundations and slabs for the apartment buildings were,
of course, on the critical path of the construction schedule,
and Mahoney seemed to be shorthanded. He started to fall
behind. Nick pushed him mercilessly. Known on the jobsite
as "Nick of time," Nick was dealing directly with
Patrick rather than going through the prime contractor,
Stu, as the protocol of the construction industry required.
Under
pressure, Patrick hired a new layout man and added three
crews to expedite the form work. At the same time, he was
pushing the rod busters who were working for him under a
separate subcontract. Details on the drawings weren't clear,
and it was hard to get information from the architect. Some
mistakes were made in the layout, and it took time to correct
them. What with one thing and another, the job was five
weeks behind schedule.
Nick's
owner's rep, Homer, an old-time construction man from Texas,
came to believe that Stu and Patrick were just incompetent
to handle a large project and keep the job on schedule.
Only he, Homer, could save the project. He and Nick laid
out a plan to do a takeover. They would remove Stu and Patrick
from the job, find a substitute concrete contractor, negotiate
a takeover of the other subcontracts and make Homer the
overall construction czar with control of the pursestrings
and progress payments. Homer, knowing that Stu was going
to be thrown off the job anyway, delayed the progress payment
that was due on January 20, citing the fact that the concrete
work was behind schedule and also quibbling about the paperwork
supporting the application for payment. Homer suddenly started
rejecting mechanic's lien releases with fax signatures,
white-outs, erasures, and dates and amounts that failed
to match the payment applied for (Civil Code §3262).
He had his clerks raise questions about certificates of
insurance from subcontractors and other paperwork details.
Stu
frantically chased down all the releases and insurance certificates
and finally presented an application for payment that was
faultless in every detail but still Homer refused to release
the check. The morale of the subcontractors and even Stu's
own superintendent and foremen was falling rapidly. Antagonism
was building up on the job. Patrick and Stu had done everything
they possibly could, but they were hampered by lack of information
on the drawings and lack of communication from the architect.
Both
Patrick and Stu were just about tapped out. For the last
several weeks Stu had focused most of his attention on releases
and insurance certificates, and now it was time to start
processing the application for the February 20 payment.
In an impassioned phone call, Patrick threatened to pull
his crews off the job. Stu dipped into his own bank account
to make a partial progress payment in return for Patrick's
promise to make up for lost time.
Stu
was not being treated fairly. His progress payments weren't
made. His working capital was exhausted. How could he be
expected to keep the job on schedule if he couldn't pay
his subcontractors? He wanted to walk off the job, but he
kept remembering that his father always boasted that he
had never failed to finish a job. He began to suspect that
if he didn't walk off the job, Nick would throw him off.
That would be even worse! What would his father think?
Stu
had been working around the clock for more a month. He was
tired and almost broke. He had to convince Homer to release
the January draw! They set up a meeting to have it out.
Stu found out that Nick intended to attend the meeting and
was also going to bring a lawyer. The job log showed a couple
of job visitors with cameras and video equipment. Stu considered
this to be an ominous development. He looked over the default
provisions of AIA document 201 and sent copies of the contract
documents and draw requests to his lawyer.
Stu
knew the ethos of the construction industry. If he performed
in a workmanlike manner on schedule and on budget with the
cooperation of the owner, the architect, the subcontractors
and the building department, he got paid. If there were
problems, he worked them out. This was something new! He
couldn't pay his bills. He'd been blown out of the water
before he had a chance to perform!
Now,
with some expensive help from his lawyer, he started to
review contract law. A contract, as he knew, was a two-way
street. "No money, no workee" was his motto. Translated
into legal language, this meant that an unexcused material
breach of contract was an excuse for nonperformance. In
other words, if one party breached the contract, the other
party had the right to stop performance. Nick was relying
on this. He said Stu breached the contract by failing to
keep to the schedule, that was a material and unexcused
breach, and therefore he was excused from making progress
payments. But as the owner, Nick impliedly warranted the
correctness of the drawings and specifications. Howard
Contracting, Inc. v. G.A. MacDonald Construction Co.,
71 Cal.App.4th 38, 83 Cal.Rptr.2d 590 (1998).
By
now, Nick was throwing in a few other "material breaches,"
such as lack of compaction, inadequate rebar and busts in
the grades of the streets. These, though, were afterthoughts.
Nick's main thesis was that Patrick was an incompetent concrete
contractor, Stu was responsible for the performance of the
subcontractor, Stu did not properly schedule the work and
was unable to make up the time that had been lost. Patrick,
on the other hand, claimed that Homer had refused to make
promised payments, that the plans were inadequate and the
architect was not available to answer RFIs (requests for
information). These factors, he contended, excused his failure
to keep the job on schedule.
Stu's
lawyer contended that Nick had committed a material and
unexcused breach of contract by failing to make the January
progress payment. He contended that the quibbling about
releases and certificates of insurance was just a ruse and
that the real objective was to keep Stu working on the job
as long as possible for free and then to eject Stu from
the job and carry on using Stu's subcontractors working
for Homer as the new construction czar.
Stu
learned that the law gave him some options. He learned that
a material and unexcused breach (failure to make progress
payment) gave him four choices: 1) continue working, finish
the contract and sue for the contract price (McConnell
v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
105 Cal.App.3d 946, 164 Cal.Rptr. 751 (1980)); 2) stop the
work but keep the contract alive, remaining ready willing
and able to continue with the project when the progress
payment had been made (B.L. Metcalf General Contractor,
Inc. v. Earl Erne, Inc., 212 Cal.App.2d 689, 28 Cal.Rptr.
382 (1963)); 3) terminate performance and sue for money
due under the contract plus profits that he could have earned
if allowed to finish the project. If withholding the progress
payment was wrongful, Stu could collect a 2 percent a month
penalty and attorney fees (Civil Code §3260.1). (McConnell
v. Merrill Lynch, Pierce, Fenner & Smith, Inc.,
105 Cal.App.3d 946, 164 Cal.Rptr. 751 (1980)); and 4) rescind
the contract (B.L. Metcalf General Contractor, Inc. v.
Earl Erne, Inc., 212 Cal.App.2d 689, 28 Cal.Rptr. 382
(1963); United States for the Use of Building Rentals
Corp. v. Western Casualty & Surety Co., 498 F.2d
335 (1974); Gray v. Bekins, 186 Cal. 389, 199 P.
767 (1921)).
Whether
to rescind, he learned, was a fateful decision. When a contract
is rescinded, the law treats it as though it had never existed
and tries to put the parties back into the position they
occupied before the contract was signed. Normally, this
meant that the owner had to give back the consideration
for the contract, but that was impossible. The streets,
curbs, gutters and foundations were embedded in the ground.
Therefore, the owner would have to pay the contractor the
reasonable value of the contractor's performance. Stu was
surprised to learn that rescission, if it worked, could
turn a losing contract into a winner because, under a theory
called "restitution," the contractor was entitled
to reasonable value of the performance even if that was
more than the contract price. B.C. Richter Contracting
Co. v. Continental Casualty Co., 230 Cal.App.2d 491,
499-500, 41 Cal.Rptr. 98 (1964).
Then
came the meeting in Nick's office. After the usual pleasantries,
Nick handed Stu a one-page document: a notice of default
that ordered Stu to remove his workers and supervision from
the jobsite and to leave the materials and equipment to
be taken over and accounted for by Homer and utilized in
the completion of the project. Black v. City of Santa
Monica, 13 Cal.App.2d 4, 56 P.2d 256 (1936). The lawyers
on both sides made their mouthpiece statements using language
that Stu could barely understand. They walked out of the
meeting crestfallen and smoldering with anger and a fierce
desire for revenge. Stu had never been subjected to anything
like this. Never would he be able to say he always finished
every job!
Stu
did something he never had to do before: He recorded a mechanic's
lien and gave a stop notice to the construction lender.
Stu started getting legal bills monthly and paying out big
money. He sued. Nick countersued. It was a race to the courthouse!
Winning this lawsuit had become the most important thing
in Stu's life. He'd been thrown off a job! No matter what
the cost, he had to prove it was not his fault, and he had
to prove it in court.
As
he got farther and farther into studying the law, he realized
that it was good thing he had not walked off the job. Then,
he would have to prove that his action was justified by
a material and unexcused breach of contract. Whitney
Investment Co. v. Westview Development Co., 273 Cal.App.2d
594, 78 Cal.Rptr. 302 (1969). Since Nick had elected to
throw Stu off the job, Nick would have the burden of trying
to prove legal justification for that action - in other
words, that Stu had committed a material and unexcused breach
of contract. Under the circumstances, was the fact that
the concrete work was a few weeks behind schedule a material
breach? If it was material, wasn't it excused by the inadequate
plans and the architect's slow responses to RFIs?
In
his heart, Stu knew that he was right. Whether a judge and
jury would agree, only time would tell.
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