| Sidestepping
a General Contractor's Backcharge Backfired
By
John S. Mrowiec
Suppose a project owner has not made final
payment to a general contractor, and the general contractor has not made final
payment to one or more subcontractors. An unpaid subcontractor could record a
mechanics lien claim.
May the owner pay the subcontractor directly to remove
the subcontractor's lien claim and receive a credit on the amount the owner otherwise
owes the general contractor without the general contractor's consent? The answer
depends on the facts. For instance, does it matter that the general contractor
claims offsets against the amount otherwise owing to the subcontractor?
Some
state mechanics lien statutes permit direct payment to subcontractor lien claimants
by owners. Some owner-contractor agreements expressly permit direct owner payments
to subcontractors. Sometimes, owners and contractors sign escrow agreements permitting
direct payments by the escrowee to subcontractors.
Other contracts do not
expressly permit direct owner payment to subcontractors and prohibit the contractor
from applying for funds not intended to be paid to a subcontractor.
Parties Caught Unawares A new case shows how both the owner
and subcontractor might be severely penalized where each ignored the general contractor's
backcharge claims against the subcontractor when the owner made direct payment
to the liening subcontractor, Environmental Energy Partners, Inc. v. Siemens Building
Technologies, Inc., 2005 Mo. App. LEXIS 1568 (So. Dist., Oct. 25, 2005).
Siemens
Building Technologies, Inc. involved a project to upgrade the lighting and to
install a new boiler and controls, new drives for the HVAC system and digital
controls at a hospital. The owner, St. John's Regional Medical Center, contracted
with a general contractor, Environmental Energy Partners Inc., for the work. The
general contractor subcontracted the HVAC drives and controls, approximately 40
percent of the total work, to Siemens Building Technologies Inc., as the controls
subcontractor.
The project schedule was based on a schedule developed by
the controls subcontractor. The subcontract contained a billing schedule and clauses
that conditioned final payment to the controls subcontractor on submission of
project documentation by subcontractor and prior payment from owner to general
contractor.
The subcontract also contained a liquidated damage provision
of $250 per day for the controls subcontractor's delay in achieving a Nov. 30,
1998, final completion.
Performance of the subcontract began in April 1998.
After Aug. 10, 1998, the controls subcontractor ceased its progress reports to
the general contractor and did not return telephone calls or otherwise communicate
with the general contractor.
Through September 1998, the owner made nine
of the 10 scheduled payments to the general contractor. The owner withheld the
tenth payment pending completion of the control subcontractor's work to be evidenced
by a completion certificate.
The contractor advised the subcontractor of
owner's withholding, but that owner had agreed to release payment to the general
contractor if a reasonable completion date were provided. The controls subcontractor
did not provide a new completion date.
The decision is unclear on the date,
but the controls subcontractor submitted a final invoice for $201,000. Apparently,
the controls subcontractor had not been invoicing consistent with the billing
schedule in the subcontract.
A Lien Filed In March 1999, the controls subcontractor
provided notice of intent to file a mechanics lien. The general contractor advised
the owner that the general contractor would indemnify the owner against the lien
claim, remarked that it was fortunate that the owner was withholding payment and
said the controls subcontractor would be terminated if it did not provide a completion
date. Importantly, the general contractor advised owner of general contractor's
intent to seek liquidated damages from the controls subcontractor.
On June
22, 1999, the owner contacted the controls subcontractor to inquire whether the
project could be completed by July 1. Instead of a response, the controls subcontractor
recorded its mechanics lien on July 1, 1999, and filed suit two weeks later for
foreclosure of the lien claim on the owner's property and for breach of contract
against the general contractor.
In January 2000, the owner reported that
the controls subcontractor had stated that the controls subcontract was complete.
Sometime prior to Jan. 24, 2000, counsel for the owner contacted the general contractor
to say that the controls subcontractor had informed counsel that the work was
complete.
The general contractor advised the controls subcontractor in
writing of the conversation, required a signature on the completion certificate
required by the subcontract and advised that payment awaited the signed certificate
and other documentation. The general contractor forwarded to the owner a copy
of the correspondence asking the owner also to sign a counterpart of the completion
certificate.
In response to the general contractor's letter, the owner's
counsel asked the general contractor whether the general contractor would waive
its liquidated damages claim against the controls subcontractor. The general contractor
said it would have to consult its attorney. The general contractor decided it
could not agree to forego the liquidated damages and so advised the owner. Neither
controls subcontractor nor owner forwarded a signed certificate of completion
at that time.
On Aug. 15, 2000, the trial on subcontractor's claims began.
That morning, the general contractor received the certificate of final completion
in the form of a letter from the owner dated Aug. 8, 2000. The general contractor
also learned that the owner and controls subcontractor had entered into a settlement
agreement, the terms of which were confidential.
The terms of the settlement
were that owner paid directly to subcontractor the $148,475 amount withheld from
the general contractor; the controls subcontractor would dismiss its mechanics
lien foreclosure at a time selected by control subcontractor's attorneys and would
indemnify owner from claims arising from the direct payment.
At the trial,
the controls subcontractor first was awarded the $52,703 difference between its
$201,000 unpaid invoice less owner's direct payment of $148,475. But the general
contractor was awarded a $154,250 off-set for liquidated damages against the amount
owing subcontractor. The off-set was merely a charge against the sum sought and
not an independent counterclaim.
(The general contractor thought its off-set
was going to be against a $201,000 claim, not the reduced $52,703 claim after
the surprise owner direct payment.) Because the off-set exceeded the award to
the controls subcontractor, the general contractor was short $101,546. 'Tortious
Interference' As a result, the general contractor sued the owner for breach
of contractor and the controls subcontractor on, among other theories, tortious
interference with the contract between owner and general contractor. The general
contractor sought the $101,546 shortfall plus interest from the owner and actual
and punitive damages from the controls subcontractor.
At a second trial,
this time on the general contractor's claims, the jury entered a verdict in favor
of the general contractor. The jury awarded the shortfall plus interest against
the owner and actual damages and punitive damages against the controls subcontractor.
The trial court eliminated the punitive damages awards on all but $500,000 for
the general contractor's tortious interference count.
All parties appealed.
The appellate court affirmed on most questions for the general contractor. The
outcome was that general contractor was entitled to recover from the owner the
shortfall in its liquidated damages that otherwise would have been recovered from
the subcontractor. Subcontractor also was ordered to pay $500,000 in punitive
damages to the general contractor.
The owner argued that general contractor
accepted the owner's direct payment to the subcontractor as "substituted
performance" of owner's obligation to pay general contractor. The Siemens
Building Technologies, Inc. court disagreed. The general contractor had no knowledge
of the payment until the first trial began and was damaged because general contractor
only owed the subcontractor $46,928, after deduction of liquidated damages, not
the $148,475 paid directly by owner to subcontractor.
The result is that
the owner had to pay that $101,467 to general contractor. If owner had not made
the direct payment, the owner would not have had to pay the $101,467 difference.
The
controls subcontractor argued that it had not tortiously interfered with the owner-general
contractor contract because control subcontractor's actions in seeking direct
payment by owner "were justified." The Siemens Building Technologies,
Inc. court disagreed, relying on the payment language in the general contract
and the subcontract:
The contract between [owner] and [general contractor]
required payment to be made to [general contractor]. The [sub]contract between
[controls subcontractor] and [general contractor] provided that until [general
contractor] was paid, [subcontractor] was not entitled to payment from [general
contractor]. The [sub]contract between [controls subcontractor] and [general contractor]
further required [subcontractor] to submit written requests for payment and certificates
of completion and to cooperate with [general contractor] in its dealings with
[owner] with respect to issues regarding payment. . . . By reason of the provisions
of its [sub]contract with [general contractor], [subcontractor] lacked the legal
right to cause [owner] to divert the payment that was to be paid to [general contractor]
to [subcontractor] (Siemens Building Technologies, Inc., 2005 Mo. App. LEXIS 1568,
* 26-27.)
The owner's and control subcontractor's plot to sidestep the
general contractor's backcharge backfired. Each of owner and controls subcontractor
suffered an expensive lesson.
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.
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