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Thelen Reid Brown Raysman & Steiner LLP
An owner hired a contractor to design and build an oilseed processing plant in North Dakota. The contractor contracted with a supplier for seed processing equipment for the plant. The supply contract included a performance guarantee that the equipment would process 200 tons of seed per day. Once the project was completed, the equipment failed to meet specified performance levels, and the plant closed.
The owner sued the contractor, supplier and the contractor's performance bond surety for breach of contract and warranty and other claims. A panel of special masters initially heard the case, and the U.S. District Court adopted most of the masters' recommendations. The court found that the supplier was directly liable to the owner for almost $1 million for project costs incurred by the owner and lost profits. The supplier appealed, and the 8th U.S. Circuit of Appeals affirmed. Aggrow Oils, L.L.C. v. National Union Fire Ins. Co. of Pittsburgh, PA, 420 F.3d 751 (8th Cir. 2005).
The issue on appeal was whether the supplier could be directly liable to the owner. Relying on a North Dakota statute, the court found that a contract made expressly for the benefit of a third person may be enforced by that third party. To determine whether the owner was a third party beneficiary, the court focused on the intent of the contracting parties, which it determined from the contract and the surrounding circumstances. The court relied on the following facts to affirm the District Court's finding that the owner was an intended third party beneficiary.
First, the court found that the supplier had a prior working relationship with the owner's general manager. And, the court noted that before entering into the design-build contract, the owner told the contractor that it had chosen the supplier to provide the processing equipment. The contractor spoke of its familiarity with the supplier. The supplier's production guarantees, in turn, became the critical element in the feasibility of the owner's processing plan. The court found that such guarantees were instrumental in the owner's selection of the supplier.
The court also found that the supplier's flow chart for the plant matched the contractor's flow chart provided to the owner, which demonstrated that the supplier also was supplying extensive engineering services in addition to equipment. The supplier's commitments, thus, created a duty to cooperate in the overall effort to attain performance guarantees. Finally, the court noted that the supplier's formal proposal identified and referenced the name of the owner's project.
The court recognized that most construction contracts do not create third party beneficiary rights for the owner. But, it concluded that this case was different. The supplier dealt directly with the owner before the contractor was retained. Performance guarantees required supplier and contractor cooperation, and the supplier knew its guarantees were critical to the economic success of the project. Therefore, the court found that the owner reasonably relied on the supplier's promise to the contractor that the equipment would properly perform, and the owner could directly enforce those guarantees against the supplier.
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For more information about the issues covered in this report, please contact Paul Berning in our San Francisco office at 415-369-7229 or at pwberning@thelen.com or contact your Thelen attorney. For more information about Thelen's Construction and Government Contracts Department, click here.
©2006 Thelen Reid Brown Raysman & Steiner LLP
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