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Construction Law Alert, April 2008

Pennsylvania Construction Decisions:
Year 2007 in Review

Through 2007, the Pennsylvania courts rendered important opinions in the field of construction law. Major decisions were issued covering a number of key subjects, including delay and acceleration claims, owner bad faith, payment of subcontractors, government contracting limitations, applicability of prevailing wage requirements and enforcement of subrogation waivers. These cases will affect construction projects in 2008 and beyond, so it behooves construction practitioners and their clients to take note. What follows are the core takeaways from these essential cases.

Delay and Acceleration Claims
In 2007, the Commonwealth Court issued two decisions affecting the award of delay and acceleration damages to contractors.

Most recently, in late November, the court weighed in on this issue with perhaps the most significant construction decision of the year. In James Corporation v. North Allegheny School District,1 a decision of first impression, the court affirmed an award of delay/ acceleration damages to a contractor based on the “measured mile” damages calculation, and also approved an award of attorneys’ fees and interest to the contractor. In that case, the plaintiff was a prime contractor for the remodeling of an elementary school owned by the defendant school district. The project was plagued with delays caused by the school district itself or third parties, yet the school district did not allow any additional time due to its patent desire to finish the project by the start of the school year.

The court concluded that the school district acted in bad faith in its unreasonable refusal to adjust contract schedules, rejection of payment applications and requests for payment for extra work without reason, threats to terminate the contractor, and refusal to make a bond claim with the contractor’s surety to coerce the contractor’s performance. This conduct led the court to render a series of significant holdings in the contractor’s favor, including refusing the school district’s attempt to enforce the “no damages for delay” provision of the contract, excusing the contractor’s untimely notice and assertion of its delay/acceleration damages claim, excusing the contractor’s failure to document extra work via appropriate change orders, and affirming a Procurement Code-based award of interest and attorneys’ fees (even though they exceeded damages awarded under the contract) due to the school district’s arbitrary refusal to make progress payments. The court also approved the trial court’s usage of the “measured mile” methodology for calculating delay/acceleration damages, where damages are measured by the difference between the costs the contractor incurred during accelerated periods and the costs incurred during normally paced operations.

Earlier in the year, the Commonwealth Court rendered another delay damages opinion and in that case also found in favor of the contractor. In Department of General Services v. Pittsburgh Building Company,2 the court upheld an award of delay damages and interest, and ordered an award of attorneys’ fees, to a contractor that had performed site excavation and related work for the construction of a National Guard armory building pursuant to a contract with the Department of General Services (DGS). The contractor encountered extensive delays on the project due to site conditions deemed unsatisfactory on account of excessive soil moisture.

The court excoriated DGS for what it concluded was DGS’s bad faith conduct in its handling of the poor site conditions, including its intentional failure to disclose to the contractor a pre-bid internal DGS memorandum in which DGS had readily acknowledged the poor site conditions, DGS’s decision to order the contractor to continue with work despite the unsuitable conditions, DGS’s failure to pay the contractor during the work stoppages it eventually ordered by relying on inapplicable contract provisions, and for refusing to make progress payments under the contract despite the contractor’s proper applications. As a result of DGS’s conduct, the court excused the contractor’s arguable failure to appropriately file its claim, and found that DGS could not rely on any of the contract’s exculpatory provisions (including a provision assigning risk for delays to the contractor), because it engaged in a constructive fraud by withholding the pre-bid memorandum. In addition to affirming the lower tribunal’s award of damages and interest, the court took the additional step of reversing the lower tribunal’s refusal to award attorneys’ fees under the Procurement Code and remanded for such an award due to DGS’s withholding of progress payments in bad faith.

Payment of Subcontractors

In a pair of decisions issued roughly a month apart, the Superior Court found in favor of two subcontractors that were not paid following performance of their work. In Imperial Excavating and Paving v. Rizzetto Construction Management,3 the court upheld an award to a subcontractor of contract damages, plus an award of interest and penalties under the Contractor and Subcontractor Payment Act (the Act), against a general contractor and its surety. There, the subcontract called for soil grading and compacting work on two high school soccer fields. Reviewing the contract requirements and the evidence of record, the court determined that the subcontractor’s work complied with the subcontract, thus entitling it to payment. The court then strictly applied the requirements of the Act and found that the $262,000 withheld by the general contractor on account of the alleged work defects did not bear a “reasonable relation” to the $120,000 that the owner had withheld from the general contractor for the same defects. The court concluded that this fact, together with the finding that the subcontractor had “substantially prevailed” on its claim for payment due to its compliance with its obligations under the subcontract, required the award of Act-mandated interest and penalties.

A month earlier, the Superior Court affirmed an unjust enrichment award in favor of a subcontractor that performed work for a general contractor but was not paid. In Northeast Fence & Iron Works v. Murphy Quigley,4 the general contractor held a contract with a prison to build fencing systems and inmate recreational yards, and to perform demolition and security system work. The general contractor hired a subcontractor to do fencing work, but the subcontractor abandoned the job after completing some of the work. The plaintiff subcontractor was hired on an emergency basis to complete the fencing work, but terms of a subcontract were never agreed upon. In affirming the trial court’s award of damages on an unjust enrichment theory, the court rejected the general contractor’s contention that it had not been “enriched” unjustly, because the completing subcontractor could not show that the prison had paid the general contractor for the subcontractor’s work. The court explained that the general contractor was in fact “enriched” because the subcontractor performed work that satisfied the general contractor’s obligation to the prison.

Public Projects Contracting
Turning to the field of government contracting, the Pennsylvania Supreme Court issued two important decisions a month apart that each appear to expand the flexibility of governments in awarding construction contracts. In Pennsylvania Associated Builders and Contractors v. Pennsylvania Department of General Services,5 the court held that the Procurement Code allows DGS to use a competitive sealed proposal process (a request-for-proposal or, RFP, process) for construction projects. DGS desired to expand the use of the RFP process because it allows for negotiation of terms with a potential contractor and does not limit the owner to the rigid lowest responsible bidder process mandated under the Separations Act. To that end, DGS had issued a policy determination in April 2005 to use an RFP process for complex construction projects in excess of $5 million. A trade association challenged this policy, arguing that the Separations Act mandated the lowest responsible bidder process. The Supreme Court, faced with the conflicting mandates of the Procurement Code and Separations Act, determined that DGS could utilize the RFP process because the Procurement Code provision allowing that process was more specific than the Separations Act and it therefore controlled.

A month later, the court, in Mechanical Contractors Association of Eastern Pennsylvania v. Commonwealth,6 held that the Department of Education was permitted to issue waivers respecting provisions of the School Code and the Separations Act that ordinarily require the separation of certain work into different contracts. The Department of Education, under the auspices of the Educational Empowerment Act, is permitted to waive requirements of the School Code if such waivers will help a school district advance its mission. In this case, a school district had applied for and received a waiver that allowed it to unify work under one contract and as a result save millions of dollars. A trade association claimed that the waiver was in violation of separations requirements, but the Supreme Court disagreed, thus permitting the school district to award work under one contract.

Prevailing Wage Act

In a pair of cases, the Pennsylvania appellate courts limited the scope and reach of the Prevailing Wage Act, which generally applies to specify the wages paid to workers in the public construction setting. In Worth & Company v. Department of Labor and Industry,7 the Supreme Court held that the Department of Labor and Industry does not have the power to force an owner to withhold funds due a contractor on account of a subcontractor’s failure to comply with the Act. In Mosaica Education v. Pennsylvania Prevailing Wage Appeals Board,8 the Commonwealth Court held that a charter school was a private operation and thus its construction projects and construction workers were not subject to the Act.

Waiver of Subrogation
In a pair of decisions, the Superior Court upheld subrogation waivers contained in construction contracts. In Universal Underwriters Insurance v. A. Richard Kacin,9 the court affirmed dismissal of a lawsuit brought by an owner’s insurance company against a general contractor and subcontractor based on allegedly faulty work that caused damages covered by the insurance policy. The court determined that the insurer was subject to the waiver of subrogation contained in the construction contract between the owner and the contractor, standard American Institute of Architects (AIA) forms A201 and A111. The court found that the wavier of subrogation provision was enforceable and did not render superfluous provisions of the standard contract relating to the contractor’s warranties of materials and workmanship. The court also enforced the waiver in spite of a lack of notice to, or consent by, the insurer.

Similarly, in Jalapenos v. GRC General Contractor,10 the Superior Court upheld a waiver of subrogation clause contained in the AIA A201 form of contract entered into between an owner and a contractor. There, the owner sued the contractor for damages caused by a fire started by a subcontractor’s employee. The court found that the waiver of subrogation clause was not void for public policy reasons, and it applied the waiver such that the owner’s remedy was limited to the insurance policy it was supposed to obtain pursuant to the form of contract. But because the owner had failed to obtain insurance and never notified the contractor of that fact, the owner was left without a remedy.

*Reprinted with permission from the March 10, 2008, edition of The Legal Intelligencer ©2008 ALM Properties Inc. All rights reserved. Further duplication without permission is prohibited.

1 James Corporation v. North Allegheny School District, 938 A.2d 474 (Pa. Commw. Nov. 30, 2007).
2 Department of General Services v. Pittsburgh Building Company, 920 A.2d 973 (Pa. Commw. April 5, 2007).
3 Imperial Excavating and Paving v. Rizzetto Construction Management, 935 A.2d 557 (Pa. Super. Oct. 23, 2007).
4 Northeast Fence & Iron Works v. Murphy Quigley, 933 A.2d 664 (Pa. Super. Sept. 18, 2007).
5 Pennsylvania Associated Builders and Contractors v. Pennsylvania Department of General Services, 932 A.2d 1271 (Pa. Oct. 17, 2007).
6 Mechanical Contractors Association of Eastern Pennsylvania v. Commonwealth, 934 A.2d 1262 (Pa. Nov. 21, 2007).
7 Worth & Company v. Department of Labor and Industry, 938 A.2d 239 (Pa. Dec. 27, 2007).
8 Mosaica Education v. Pennsylvania Prevailing Wage Appeals Board, 925 A.2d 176 (Pa. Commw. May 8, 2007).
9 Universal Underwriters Insurance v. A. Richard Kacin, 916 A.2d 686 (Pa. Super. Jan. 11, 2007).
10 Jalapenos v. GRC General Contractor, 939 A.2d 925 (Pa. Super. Dec. 19, 2007).

Bankruptcy Filings Surge in 2007

The number of construction companies filing for bankruptcy surged in the last three months of 2007 as the slow real estate market and tighter credit began taking its toll on builders. In this economic downturn, surety companies will need to consider whether they and their principals are at risk. The big question for sureties is what can be done if a surety’s principal files for bankruptcy. The following is a brief primer/reminder of some things worth considering:

Information gathering: Filing of bankruptcy by a bonded principal can be an opportunity for the surety to obtain critical information:

– First meeting of creditors (Section 341 meeting): Provides opportunity to examine the debtor regarding its financial dealings, assets and liabilities.

– 2004 Examination: Any party “in interest” may move for an examination of the debtor under Bankruptcy Rule 2004.

Proof of claim filing deadlines: The surety will receive notice of the bankruptcy filing. In Chapter 11, the bar date for filing a proof of claim will be set upon motion, with notice to all creditors. In the Chapter 7 asset case, the bar date for filing a proof of claim is 90 days after the originally scheduled first meeting of creditors.

Adequate protection: The surety can seek relief from the automatic stay in order to obtain “adequate protection” or have collateral abandoned by the bankruptcy estate if the surety has a security interest in receivables, equipment and inventory of the debtor and reason to believe the debtor is improperly depleting assets.

Contract funds: Often, the easiest way for the surety to protect itself is to secure remaining contract funds. Contacting the owner to request that it hold funds and not disburse additional funds to the principal will not usually be considered a violation of stay.

– Under the principle of equitable subrogation, bonded contract proceeds are held for the benefit of unpaid subcontractors, and may be available to a surety if it has paid subcontractors under its payment bond.

Preference issues: The Trustee may assert a preference claim against a surety to recover payments made by the debtor to subcontractors during the preference period, based upon the argument that the contractor’s payment improperly benefited the surety. Most significant defenses to such a preference claim include contemporaneous exchange for new value and ordinary course of business. If the project is in a trust fund statute state, the statute may require that contract funds be deemed to be held in trust for the benefit of downstream subcontractors and suppliers.

Jeffrey D. Grossman
Karl S. Myers
Construction Law Alert, April 2008
Construction Law Alert, June 2007
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