Determining Who Breached a Contract First

By John S. Mrowiec

One of the most frequently asked questions during a construction project is whether under the particular circumstances a subcontractor is entitled to suspend or to terminate performance or, on the other hand, for the contractor to terminate the subcontractor.

It often is a difficult question to answer.

The subcontract normally addresses the right and preconditions to a subcontractor suspending or terminating performance in the context of a contractor's failure to pay approved pay applications. Likewise, the subcontract provides the conditions for the contractor's right to terminate the subcontract.

A clear failure by a contractor to pay an approved subcontractor pay request - especially if paid to contractor by the owner - does not usually present a difficult issue. But arguments regarding changed conditions, failure to approve change orders or rejected pay applications often constitute "disputes."

Depending on the language of the contract, these disputes might require adherence to the subcontract's dispute resolution provisions before suspension or termination is appropriate.

This month we discuss a court decision involving a subcontractor who suspended performance and a contractor who subsequently terminated the subcontract and sought the excess completion costs, Advance Iron Works, Inc. v. John Edwards Construction Co., 2004 U.S. Dist. LEXIS 18066 (Sept. 9, 2004).

Redo Project Illustrates Issue

The contractor, John Edwards Construction Co., contracted with the Department of Veterans Affairs to renovate the Reactivation Center located at the Edward Hines Jr. VA Hospital in Hines, Ill. The Project was to be completed in approximately 18 months.

The contractor subcontracted the steel fabrication and erection to Advance Iron Works for $220,000. In turn, the subcontractor entered into a sub-subcontract with a steel erector to perform the erection scope for $50,000.

The subcontract provided for periodic progress payments. Each of the subcontractor's first three progress payment requests were flawed. The first progress payment request failed to deduct retention. The contractor paid the first request less retention without requiring the subcontractor to correct and to resubmit the request.

The subcontractor's second request substantially overstated progress. The owner rejected the contractor's payment application that contained the subcontractor's overstated progress. Without the subcontractor's input, the progress was readjusted. The contractor paid the reduced amount without requiring resubmission of the subcontractor's pay request.

The contractor included the subcontractor's third pay request in an application to the owner. The owner again disputed the subcontractor's estimate of progress and rejected the contractor's pay application. The contractor resubmitted the application to the owner without change and without requesting any revised request. When resubmitted, the owner paid and, in turn, the contractor paid the subcontractor.

In the meantime, the sub-subcontractor erector had experienced delays. The subcontract provided that the contractor was to provide a suitable, level compacted steel lay down area and access for cranes, equipment and trucks to the point of the pick. The erection work was to be based on Occupational Safety and Health Administration standards for steel erectors.

There were a number of days of rain. The contractor failed to provide a proper road that would have provided a suitable crane base even shortly after a rain day. There also were foundation delays that allegedly delayed steel erection.

The subcontractor submitted a request for change order for $5,676 for trucking, storage and increased ironworker rates resulting from the delays.

The contractor did not approve the change order request but continued to request information and documentation regarding the request.

On Aug. 1, 2000, the subcontractor submitted a fourth pay request certifying that the work was complete. However, 50 steel bracing angles, a link beam and all of the canopy steel still remained to be installed. The canopy steel could not be erected until the delayed foundations had been completed.

The contractor returned the subcontractor's fourth payment request asking for corrections. The subcontractor did not resubmit the request.

On Sept. 28, 2000, the contractor ordered the subcontractor to have the bracing and the link beam installed and advised that the canopy steel erection could commence on Oct. 9 and subcontractor's other work should be completed by then.

On Oct. 11, when the subcontractor had not begun to complete its work, the contractor sent a seven-day notice pursuant to the provisions of the subcontract to return to the project or face termination. The subcontractor responded that it would not return unless the contractor approved the change order request and paid $10,000 to be used to pay the erection sub-subcontractor.

Disputes regarding change orders were to be a "claim" under 4.3 of the American Institute of Architects General Conditions, which were incorporated in the subcontract. "Claims" were required to be submitted and initially decided in accordance with the subcontract. The subcontract's General Conditions also provided for mediation and arbitration.

By Oct. 24, 2000, the subcontractor still had not proceeded with the completion work. Therefore, the contractor sent a second and final seven-day notice.

The next day, the subcontractor advised that a provision of the subcontract permitted the subcontractor to cease work for non-payment. That subcontract suspension provision required seven days' prior written notice. The subcontractor repeated its earlier demand for approval of the change order request and $10,000 payment to be used to pay the erector.

The contractor responded that the subcontractor had never given the required "intent to suspend" written notice and that the subcontractor had never resubmitted a corrected fourth payment request, so there was nothing unpaid.

On Nov. 1, 2000, when the second seven-day period had expired, the contractor sent a Notice of Termination. The subcontractor replied that it would return to the site provided the contractor paid the change order request as now increased. The contractor declined.

The contractor then was forced to sue the subcontractor to obtain the canopy steel for which the contractor previously paid the subcontractor in the first three pay applications. The parties settled that part of the dispute. They reserved their rights otherwise.

When the erector tried to erect that canopy steel, however, certain tube steel was missing. The subcontractor claimed it had been shipped to the site long prior to any disputes arising. The contractor disagreed. The contractor purchased the missing steel, the erector completed the erection and the contractor sent notice of a backcharge to the subcontractor for the cost of completion.

The subcontractor sued the contractor and contractor's co-sureties for payment in federal district court. The contractor defended on various grounds.

Who Breached Contract?

The outcome depended primarily on which party had materially breached the subcontract first under Illinois law. The governing principles, according to the Advance Iron Works court, were:

1. "A material breach occurs where the covenant not performed is of such importance that the contract would not have been made without it" Advance Iron Works, 2004 U.S. Dist. LEXIS 18066, *21 quoting Dragon Construction v. Parkway Bank & Trust, 287 Ill. App. 3d 29, 678 N.E.2d 55, 48 (1st Dist. 1997).

2. "Once a contract has been materially breached, the non-breaching party is discharged from its duty to perform" Advance Iron Works, 2004 U.S. Dist. LEXIS at *21-22 citing Dragon Construction, 678 N.E.2d at 58.

3. The non-breaching party may cease further work, declare the contract at an end and recover the value of the work already performed, Advance Iron Works, 2004 U.S. Dist. LEXIS at *22 citing B&C Electric, Inc. v. Pullman Bank & Trust Co., 96 Ill. App. 3d 321, 421 N.E.2d 206, 211 (1st Dist. 1981).

4. "Where a party has materially breached a contract, he cannot take advantage of terms of the contract which benefit him nor recover damages from the other party to the contract" Advance Iron Works, 2004 U.S. Dist. LEXIS at *22 quoting Robinhorne Construction Corp. v. Snyder, 113 Ill. App. 2d 288, 251 N.E.2d 641, 645-646 (3d Dist. 1969).

The Advance Iron Works court found that the subcontractor was legally entitled to suspend performance for two material breaches by the contractor and the contractor was not entitled to completion costs from the subcontractor.

The contractor's first material breach was the failure to provide adequate site access causing delayed progress. Even though that was a $5,756 issue, the subcontractor had not submitted the dispute as a "claim" under paragraph 4.3 of the General Conditions and the subcontractor had not sought mediation or arbitration, the court decided it was a material breach justifying subcontractor's suspending the work.

The contractor's second material breach was the failure to pay the undisputed portion of subcontractor's payment request. The contractor argued that the subcontractor had failed to correct and to resubmit the overstated fourth payment request.

But the Advance Iron Works court held that the contractor had waived the failure to resubmit as a defense to paying the undisputed amount. The contractor's payments of reduced amounts on earlier pay requests without first requiring resubmission were a waiver of the right to insist upon conforming pay request provisions, Advance Iron Works, 2004 U.S. Dist. LEXIS at *21 citing In re Krueger, 192 F.3d 733, 742 (7th Cir. 1999).

The contractor, however, was able to salvage something. The Advance Iron Works court held that the subcontractor materially breached the settlement agreement regarding the canopy steel by failing to supply the missing pieces.

The contractor was entitled to set-off some costs and the erector's unpaid sub-subcontract balance against the amount owed to the subcontractor.

However, the set-off was not because of any wrongful subcontractor's suspension but for the subcontractor's material breach of the separate settlement agreement on the canopy steel issue.

John S. Mrowiec is a partner with Chicago-based Conway & Mrowiec, a construction and public contracts law and litigation practice. He may be reached at (312) 658-1100. For information, go to the firm's Web site at www.cmcontractors.com.