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James Paulding, student in the Colleges of Law’s J.D. program, offers eight detailed ways that public agency owners and construction managers can protect themselves from a general contractor’s legal claims.

Public agency owners and construction managers understand the intricate web of relationships and contractual agreements that stand behind massive public-works projects. When timelines are delayed and expectations aren’t met, an equally complicated dance of litigation claims between owners and contractors can—and almost always will—occur.

Allow me to share a story.

It started when the lowest responsive and responsible bidder was awarded the contract for construction of a multimillion-dollar public works project. A few months into the project, this general contractor experienced a dramatic spike in material costs, a shortage of competent labor, and a high rate of project management turnover—all due to market conditions. This caused the general contractor to suffer real losses on the project. Their losses, however, were not the owner’s responsibility under the fixed-price contract.

In order to remain profitable and recover their losses, the contractor implemented an aggressive claim strategy throughout the course of construction—which ultimately proved successful.

Not only did the contractor supply the project with less than half of the planned and scheduled manpower, they were late in submitting the vast majority of their project material and equipment submittals—shop drawings, samples, O&M manuals, mockups, models, data, etc.—for review and approval by the architect/engineer (A/E).

This negatively impacted their procurement of major plant process equipment, which snowballed into late equipment installation, startup, testing, etc. Other major failures to coordinate the work led to quality control issues—such as installation of the motor control centers without approved submittals and shop drawings.

Notwithstanding the owner’s robust documentation of the contractor’s failure to follow the contract specifications for preserving and proving claims, the contractor was successful in litigating their claims against the owner.

Their success was in part due to the way in which the owner chose to administer the contract.

The Contract Provisions

The contract, like most design-bid-build/low-bid public works contracts, contained boilerplate notice of delay and time extension provisions. The contractor was required to submit written notice to the owner of any delay encountered within seven days of the initial occurrence.

If impacted by the delay, the contractor was required to submit a request for time extension to the owner showing the delay’s impact to specific activities on the most current version of the project’s official progress schedule. If the contractor’s official progress schedule showed more than a 14-day delay to project completion, the contractor was required to submit a recovery schedule detailing the contractor’s plan of action to recover and complete the project on time. The terms stated that, if the contractor failed to complete a contractual milestone on time, the contractor would be assessed liquidated damages in the amount of $3,000 per day for each day that the work remained incomplete.

When the contractor fell behind schedule, they employed multiple tactics to circumvent the contract’s delay provisions. For example, after they submitted their monthly progress schedule update showing more than a 14-day delay to contract completion, the owner responded with notice that they were required to submit a recovery schedule per contract requirements.

The contractor immediately responded by submitting notice of two delay impacts that had purportedly occurred, along with a request for time extension. The owner timely responded by citing contract requirements to submit substantiation of the delays (i.e., a schedule network window showing the specific critical path activities that were impacted) for the owner’s review. The contractor chose not to provide the requested substantiation. In fact, the contractor did not respond to the owner’s request at all.

As the project’s schedule continued to slip, the owner continued to document in detail the contractor’s administrative noncompliance and lack of progress in the field. The owner repeatedly put them on notice that late submittals and lack of labor were the documented cause of project delays, and substantiation for the two claimed delay impacts was required to be submitted in order for the owner to evaluate and approve any contract time extensions.

The contractor continued to provide the same written response—without providing any substantiation of delay impacts—that they were owed time for the two noticed delay impacts, and the owner was being “unreasonable” in not granting the time owed. Never once did they address or respond to the owner’s repeated statement that the cause of delays, based on the analysis and information available to the owner, was actually the contractor’s late equipment and materials submittals and their lack of manpower on the job.

As the project progressed, the contractor continued to play the same game. At the weekly meeting, the owner would review the number of outstanding submittals with them and discuss and forecast the downstream impacts associated with their delay. These discussions were recorded in minutes of the weekly progress meetings.

The owner also used photo and video documentation to document each location in the field where the contractor could have been working in accordance with their own planned schedule, but were not. Every week, the owner would send the photos and videos to the contractor along with drawings depicting the areas where no work was being performed, asking for an explanation as to why there was no progress being made in those areas and why they were deviating substantially from their planned schedule. The contractor submitted no response to these requests for an explanation.

After the contractor started missing contract milestones as the owner forecasted they would, the owner first put them on notice that they would be assessed liquidated damages at $3,000 per day per contract requirements if recovery was not made, and then started assessing liquidated damages when recovery was in fact not made. At one critical juncture, in response to the owner’s repeated requests for a recovery schedule or any plan of action to recover, the contractor stated that they would prefer to be assessed liquidated damages in lieu of submitting a recovery schedule.

After all was said and done, the contractor delivered—one whole year late—an incomplete project with a long list of punch list items. Examples of incomplete work include plant facility controls automation (the owner had to hire a consultant to complete the work), non-submittal of required spare parts, and a whole host of other big ticket punch list items that were eventually completed by the owner.

What can an owner do to protect itself in this situation?

You may ask why didn’t the owner terminate the contract? Keep in mind that perfect construction documents are impossible. Any savvy contractor’s claim will maximize focus on design errors and omissions, unforeseen site conditions, and owner requested changes while minimizing focus on contractor-related causes for cost and time overruns. This is the reason for strict enforcement of detailed construction change order procedures that require the contractor to quantify cost and time impacts with itemized cost proposals and schedule analysis in order to separate the wheat from the chaff (i.e., the costs which they are entitled to additional compensation for as opposed to the costs for which they are not).

The problem encountered in this case falls in the grey area where the owner is faced with a contractor that performs the work but does so late and acts as though they are complying with contract procedures while in actuality they are not. Oftentimes, this would be characterized as a “concurrent delay” (i.e., the delay is in part attributable to the owner for one or more of the reasons described above). But in this case, the contractor simply filed two delay claims with no supporting documentation and carried on with the project, thus leaving the delay claims unresolved. Does this conduct amount to a breach of contract such that the contractor may be terminated? Breach of contract or “default” is a material unexcused failure to perform.

If a contractor materially defaults, the owner has four choices:

1. Terminate the contractor’s performance, stop the job, and keep the contract alive. B. L. Metcalf General Contractor, Inc. v. Earl Erne, Inc., 212 Cal.App.2d 689, 28 Cal.Rptr. 382 (4th Dist.1963)
2. Rescind the contract. B. L. Metcalf General Contractor, Inc. v. Earl Erne, Inc. 212 Cal.App.2d 689, 28 Cal.Rptr. 382 (4th Dist.1963)
3. Allow the contractor to continue and sue for damages. McConnell v. Corona City Water Co., 149 Cal. 60, 85 P. 929 (1906)
4. Under appropriate provisions, delete a portion of the work Cal. Constr. L. Manual § 1:62 (6th ed.)

Did the contractor’s performance in this case amount to a material unexcused failure to perform? Doubtful. If the owner pursued that path, they would have taken on the additional headache of getting a new contractor on board through the contractor’s surety—which is not a smooth process and would be sure to delay the project even more. Not to mention, it may put the owner in the position of defending the claims that would inevitably be filed by the contractor. For example, if a judge or arbitrator determined that the contractor was not in material breach, the contractor would be entitled to damages that could include lost profits and other big-ticket claims.

What the owner chose to do was to let the contractor complete the work and assess liquidated damages for their late completion. Notice of final acceptance was issued years after the contractor walked off the project, and after the owner hired separate contractors to complete the work in order to get the plant fully operational. Because the total value of the owner’s ongoing assessment of liquidated damages for every day the project continued to be incomplete after the original contract completion date was close to the remaining contract balance and retention owed the contractor, the owner chose to withhold the contract balance and retention and make a final payment of zero dollars to the contractor as part of project acceptance.

The owner relied on the decision in Opinski v. City of Oakdale (2011) 199 Cal.App.4th 1107, to defeat the contractor’s unsubstantiated claims. In that case, the court upheld liquidated damages for the general contractor’s late completion under their construction contract, even when the delays were caused by the city’s conduct, where the contract required any extension of time to be obtained through certain procedures and the general contractor failed to comply with such procedures. The owner expected that this decision would support their position.

The contractor filed a claim against the owner to be arbitrated per contract requirements outlining their two noticed delay claims again with little supporting documentation. Notwithstanding the contractor’s documented “breaches,” they were successful—after a prolonged and expensive discovery process—in recovering their previously withheld contract balance and retention in a mediation settlement (mediation being a required pre-step to arbitration in this case).

I saw how the contractor successfully convinced the mediator that their claim had merit. From an arbitrator’s perspective, even a fraction of merit is considered merit, and once this was established, the owner’s defense was significantly weakened[1]. They established merit to their claim by the following actions:

• They garnered sympathy by focusing on the fact they had encountered “categorical” actual cost impacts, such as increases in material cost due to market conditions and labor cost overruns, notwithstanding the fact that, had the market gone the other way, any windfall received by the contractor would not have been credited to the owner.
• They weakened the owner’s position on their delay claim issues by showing emails out of context that could be interpreted such that the owner had seen merit to their claims during construction. Even though the owner did an excellent job refuting the technical merits of these claims, the mediator thought the “paper trail” weakened their position.
• They were able to make it appear as though they had been responsive to the owner’s repeated requests for documentation supporting their claimed delay impacts even though their responses were “nonresponses.” This was notwithstanding the excessive documentation of nonperformance that the owner repeatedly sent to the contractor along with requests for substantiation throughout the course of the project.
• They focused on the fact that they should have been granted time extensions had they fully complied with contract requirements, downplaying the notion that they had failed to comply by submitting the required supporting documentation justifying the delays.
• They argued that the owner acted in “bad faith” by retaining their contract balance and retention after deducting the total assessed value of liquidated damages.
• They argued that they had achieved “substantial completion” notwithstanding the fact that the facility was not fully commissioned and operational and there were a host of outstanding punch list items.
• And finally, they made a convincing argument that they were at least entitled to all or a portion of the contract balance and retention that had been withheld. Even if owed just a small sum, after tacking on interest, penalties, and attorney fees—they were owed millions of dollars.

In sum, the contractor was successful in establishing some merit to their claim, albeit a small amount. This seemed to completely negate the owner’s ability to fully defend their position.

How Owners and Their Construction Managers Can Mitigate These Situations.

1. Engage your legal counsel early on.

Not only in the review of your contract documents before you bid the project, but when you see warning signs such as the “nonresponse” response described above.

2. Create and foster a fair and equitable relationship with your contractor so they do not take a “recover costs through claims” approach to your project.

If a general contractor has quantifiable actual cost impacts that you are not contractually obligated to address, take full advantage of all opportunities to offset these impacts within the bounds of your contractual limitations.

3. Manage and control your project team and record to avoid paper trails that can be used against you down the road.

Always treat issues and the correspondence surrounding them as if they will be viewed by the other side or an arbitrator or judge at a later date.

4. Ensure that the project record reflects your efforts to be proactive, fair, and equitable in executing the contract.

The more you can demonstrate to an arbitrator or a judge that you and your project team acted in good faith throughout the course of the project, the better you will fare. Likewise, if the project is going downhill, consider—with the assistance of counsel— documentation strategies that will highlight to a judge or arbitrator the good faith measures you have taken to achieve dispute resolution with the contractor.

5. Facilitate the swift resolution of cost or time impacts as proactively as possible within the bounds of your contractual limitations.

One way to accomplish this goal is to incorporate a unilateral change order clause into the general construction contract that allows you as the owner to direct the contractor to proceed with the extra work based your or your consultant’s estimation of the cost/time to perform the added scope of work. Thus, when negotiations fail or the contractor fails to comply with contract requirements, the fact that you pay them to perform or extend the contract time based on a reasonable estimate is better than not paying the contractor at all due to their procedural noncompliance with contract requirements.

This good faith attempt to “mitigate damages” will hopefully avoid interest and penalties[2] being tacked on down the road to the money the contractor was legitimately entitled to but was never paid due to a lack of resolution of actual cost/time owed. Be sure to attach your cost estimate and supporting documentation to the change order and then carefully track and document all of the contractor’s resources utilized in performing the work (as if the work was performed on a time and materials basis).

6. If you choose to assess liquidated damages, stop assessing them when the project is “substantially complete” or when actual damages are no longer incurred.

Civil Code § 1671(b) provides that, “Except as provided in subdivision (c), a provision in a contract liquidating the damages for the breach of the contract is valid unless the party seeking to invalidate the provision establishes that the provision was unreasonable under the circumstances existing at the time the contract was made.”[3]

Thus, the law states that, as long as a public agency can show that the liquidated damages amount is reasonable at the time it is established, i.e., at the time of contract formation, it does not have to show actual damages in order for them to hold water. However, you have a much better argument if you can demonstrate actual damages/cost impacts.

Therefore, it is best advised to keep a pristine record of your actual damages to assist you in any downstream litigation. If you have no actual damages, it may be prudent to reconsider whether it is necessary to continue assessing liquidated damages.

7. Don’t expect the false claim provisions in your contract to protect you.

In other words, don’t expect that these provisions will deter a contractor from submitting what you think is a false claim and don’t expect to prevail in an action against the contractor for submitting a “false claim” under California Government Code Section 12650 et seq., which is modeled after the federal False Claims Act (31 U.S.C section 3729).

Based on my experience, owners that go down this road do so unsuccessfully—given the inherent difficulty in proving that the contractor submitted a claim that was in fact “false” and did so “knowingly” (i.e., had actual knowledge of that the information was false; acted in deliberate ignorance of the truth or falsity of the information; or acted in reckless disregard of the truth or falsity of the information).

8. Consider the pros and cons of binding arbitration.

On one hand, arbitration is consistent with the state legislature’s strong public policy in favor of arbitration as a speedy and relatively inexpensive means of dispute resolution. (Woolls v. Superior Court (2005) 127 Cal.App.4th 197.) And this preference for arbitration in the public sector is embodied in Public Contract Code §§ 10100 et seq., the State Contract Act, which applies to the construction, alteration, repair, or improvement of public structures, buildings, roads, and other improvements, and provides for arbitration of claims under state contracts.

On the other hand, it is argued that arbitration is not inexpensive especially when dealing with the American Arbitration Association, which charges hefty fees. Other concerns range from an arbitrator’s potential bias toward owners or contractors based on their experiences, modified discovery rules, ability to join other parties, and the list goes on[4].

However, in most cases, parties can obtain an arbitration award faster than a court judgment. “Speed of decision is, in fact, the most important difference between arbitration and litigation.” (Cal. Constr. L. Manual § 3:66 (6th ed.) Keep in mind that “a party with a bad case has little motive to accelerate proceedings and may indeed prefer delay to speed, and, therefore, litigation to arbitration.” (Ibid.)

Conclusion

The above story and associated recommendations are a non-exhaustive attempt to provide some level of guidance to public sector owners who face difficult general contractors, a problem that is largely the result of the imperfect design-bid-build project delivery method.

Bottom line: be fair and be proactive.

Appendix

[1] Note that arbitrators, unlike judges, are free to disregard case law and resolve disputes based on equitable considerations. Likewise, they are not bound by the terms of the contract. Arbitrators, unless specifically required by the arbitration agreement to act in conformity with rules of law, may base their decisions on broad principles of justice and equity, and in doing so may expressly or impliedly reject a claim that a party might successfully have asserted in a judicial action. (San Jose Federation etc. Teachers v. Superior Court (1982) 132 Cal. App. 3d 861.)

[2] Public Contract Code § 7107 requires that a public agency make payment of a retention within 60 days after completion of the project. “Completion” means occupation, beneficial use, or acceptance by the public agency or a cessation of labor on the project for a continuous period of 100 days. The penalty in both cases is two percent per month in lieu of interest, and attorneys’ fees and costs go to the prevailing party. Civil Code section 3287, subdivision (a) provides: “A person who is entitled to recover damages certain, or capable of being made certain by calculation, and the right to recover which is vested in him upon a particular day, is entitled also to recover interest thereon from that day, except when the debtor is prevented by law, or by the act of the creditor from paying the debt.” Under this provision, the trial court has no discretion—it must award prejudgment interest from the first day there exists both a breach and a liquidated claim. (North Oakland Medical Clinic v. Rogers (1998) 65 Cal.App.4th 824, 828.) Prejudgment interest compensates the plaintiff for the loss of the use of property or money during the period before the judgment is entered. (Id. at p. 828.) Civ. Code, § 3287, subdivision (c) provides: “Unless another statute provides a different interest rate, in a tax or fee claim against a public entity that results in a judgment against the public entity, interest shall accrue at a rate equal to the weekly average one year constant maturity United States Treasury yield, but shall not exceed 7 percent per annum. That rate shall control until the judgment becomes enforceable under Section 965.5 or 970.1 of the Government Code, at which time interest shall accrue at an annual rate equal to the weekly average one year constant maturity United States Treasury yield at the time of the judgment plus 2 percent, but shall not exceed 7 percent per annum.” (Civ. Code, § 3287.)

[3] Note the exceptions set forth in subdivision (c), which include consumer contracts, rentals, and residential leases, are not relevant to this discussion.

[4] Note that the Public Contract Code regulations governing State Contract Act arbitration allow discovery, permit joinder, and require the arbitrator to follow the law and the contract and to issue written findings of fact/conclusions of law. (PCC §§ 10240.8. through 10240.11.)

Last week, The Santa Barbara & Ventura Colleges of Law hosted a debate on whether California voters should repeal the death penalty.