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Contractor Allowed to Sue Local Agency for Lost Profits After Bonding Capacity Was Impaired; Default Was Wrongful
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May 17, 2010
By Christian F. Henel
The Colorado Supreme Court has held that a contractor may use impaired bonding capacity as the basis for a claim of lost profits in a breach of contract action.
After a competitive bidding process, the Denver Board of Water Commissioners contracted with Denny Construction, Inc. to build a new board headquarters for $3.5 million. Denny had more than 30 years of experience as a general contractor in building private and public construction projects in the Denver area.
The contract called for Denny to complete the project by July 2003. Construction was delayed for several months because of weather, and each of Denny’s requests for time extensions were denied by the Board except one, an extension to October 2003. As a result, Denny’s work was incomplete when the board occupied the new building in November 2003.
The board withheld $260,000 of Denny’s contract price because of the unfinished work and declared Denny in default in April 2004. The board filed a claim with Denny’s surety, Insurance Company of the West. Within four months of the board’s default declaration and bond claim, the surety had reduced Denny’s bonding capacity, and later it stopped writing bonds for Denny altogether. Denny was unable to obtain bonds from other sureties.
Shortly after that, one of Denny’s subcontractors sued Denny and the board for payment, which was part of the $260,000 held back by the board. Denny and the board cross-claimed against each other for breach of contract. The subcontractor settled its claims early on in the litigation and was released. Denny and the board went to trial.
At trial, Denny argued that it had substantially performed the contract and that the board had wrongfully denied Denny’s multiple requests for time extensions for bad weather. The board argued that the contract required time extensions only for “abnormal” weather and that Denny was not entitled to additional time extensions.
Denny put on extensive evidence that it had lost profits as a result of the board’s default declaration and bond claim. The core of Denny’s lost profits claim was based on the loss in bonding capacity that it suffered. Denny introduced evidence showing that: (1) it had been profitable in the years before the project; (2) it had historically derived half of its revenue from public projects; (3) it routinely bid on and was awarded contracts for public projects; (4) there were available public projects that Denny would have bid on had but could not because Denny no longer could obtain the bonds necessary to bid; and (5) Denny’s profits declined after the default declaration and loss of bonding capacity.
Denny presented financial statements, lists of contracts, and lay and expert testimony to support its claim that reduced bonding capacity directly resulted in lost profits. An underwriter from Denny’s former bonding company testified that the board’s bond claim was the primary reason why Denny’s bonding capacity was reduced and then eliminated. Denny’s bond broker testified that other sureties refused to write bonds for Denny and that the board’s claim precluded obtaining bonds from other sureties. Denny’s damages expert testified that Denny had lost or would lose profits of nearly $1.6 million. The board presented no expert testimony of its own; it just cross-examined Denny’s witnesses.
The jury returned a verdict for Denny for breach of contract and awarded Denny $1,063,000 in damages, which included $845,000 for lost profits.
On appeal, the Colorado Court of Appeals reversed. Noting the longstanding rule in Colorado that a contractor may only recover lost profits if it can prove (1) the claimed lost profits were not speculative or uncertain and (2) the claimed lost profits were of the type “reasonably foreseeable” at the time of contracting, the Court of Appeals held that Denny’s claim for lost profits did not meet that standard.
On the “certainty” prong of the test, the Court of Appeals held that lost profits resulting from impaired bonding capacity were “speculative as a matter of law” and thus could not be allowed. On the “foreseeability” prong of the test, the Court of Appeals held that Denny’s lost profits in the form of impaired bonding capacity were not “reasonably foreseeable” by the board at the time of contracting because there was no evidence that the board actually knew that Denny would lose profits if its bonding capacity were to become impaired.
The Colorado Supreme Court reversed the Court of Appeals. Denny Construction, Inc. v. City and County of Denver, 199 P.3d 742 (Colo. 2009).
First, the Supreme Court held that the effects of impaired bonding capacity on lost profits are not speculative as a matter of law but are quite real. The court described at length and in detail the significance of bonding capacity as a factor in obtaining public works contracts. It noted that a contractor simply cannot be considered a “responsible” bidder unless it can obtain the bonds required by bidding documents, and the court observed: “Bonding capacity provides the best measure of a contractor’s responsibility.” The court cited the testimony of the board’s own employees, who testified at trial that bonding capacity is an important factor in obtaining public works contracts. The court noted that under Colorado law, a public works contract may not be awarded to a contractor that cannot post a bond for the project.
Based on these factors, the court concluded that impairment to a contractor’s bonding capacity was not speculative but instead had a direct impact on a contractor’s ability to obtain future public work.
The court dismissed arguments by the board that impairment of bonding capacity could not be the basis for lost profits because profit depends on a number of uncertain factors, such as weather, efficiency, and changes in costs and management. While those factors could affect profits, the court held, that was no reason -- as a matter of law -- to preclude recovery of lost profits resulting from impaired bonding capacity.
Rather, the court held, Colorado law allows the recovery of lost profits if they can be proven with reasonable certainty. If the fact of future loss is certain, the court wrote, the amount of damages awarded may be an approximation. The court noted that in a number of cases, a business’ prior profitability was found to provide a reasonable basis for computing profits.
Second, the Supreme Court held that the Court of Appeals erred when it employed a subjective, actual knowledge standard to determine whether lost profits due to impaired bonding capacity were reasonably foreseeable to the board at contracting. Instead of focusing on whether the board actually knew that such lost profits would occur, the Court of Appeals should have applied an objective standard and focused on whether the board knew or should have known such lost profits would occur, the Supreme Court held.
The Supreme Court did not decide whether the board knew or should have known that Denny’s impaired bonding capacity would cause it to lose profits and remanded the case for determination of that issue. The Supreme Court did note that two board employees involved with the board’s construction program and the decision to declare Denny in default acknowledged at trial that they understood the role of sureties in public works projects and that contractors without bonding capacity would not be considered for projects. The Supreme Court also noted that the board was generally familiar with Denny’s financial condition and profitability from prequalification documentation it had provided.
Finally, the Supreme Court rejected the board’s argument that it was immune under the doctrine of sovereign immunity. Rather, the Supreme Court held, the Colorado Legislature had enacted laws providing that public agencies should be treated no differently than private parties in contract litigation.
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