The Construction Advantage

Exceeding authority, automatic stays, and equitable adjustments:  In this month’s Construction Advantage, we summarize a Third Circuit case where the automatic stay in bankruptcy kills off two mechanics liens, an arbitrator is found to have exceeded its authority in Rhode Island, and the Board of Contract Appeals discusses the ever murky area of equitable adjustments on government projects.

Tucci & Sons, Inc. Dept. of Transportation, 2016 CIVBCA 4479 (Dec. 20, 2016)

By: Conor Shankman

Last December, the U.S. Civilian Board of Contract Appeals (the “board”) denied an appeal by earthwork contractor Tucci & Sons, Inc. (“Tucci”) on its claim for equitable adjustment to a contract to reconstruct portions of road in Mount Rainer National Park. Problems arose when Tucci began excavation and immediately encountered boulders, because Tucci’s bid did not include costs for the breaking or blasting of rock.

As a result, Tucci requested an equitable adjustment of $81,130, to the original contract price of $10,099,717. Its claim was promptly rejected by the Department of Transportation (the “DOT”), which  argued that the presence of boulders did not constitute a “differing site condition.” Therefore, Tucci was not entitled to a Type I or Type II equitable adjustment to the contract price.  Tucci then appealed this denial to the Board.

The board noted that the “purpose of [a] Differing Site Conditions clause is to allow contractors to submit more accurate bids by eliminating the need for contractors to inflate their bids to account for contingencies that may not occur.” Further, differing site conditions can arise in two possible different circumstances: “(1) the conditions encountered differ from those indicated in the contract (Type I), or (2) the conditions encountered differ from those normally encountered (Type II).”

The board went on to state that the burden for establishing a Type II difference is substantial, and that Tucci ultimately failed to carry this burden. Moreover, Tucci had been on notice that boulders might be present for a number of reasons:

• Boulders were present on the sides of the preexisting road
• The contract drawings indicated the presence of “undisturbed native material”
• The presence of rock outcroppings and rock faces adjacent to the roadway provided adequate notice that boulders might be present

The board similarly rejected Tucci’s Type I claim. “The underlying issue in a Type I claim is whether the contractor could reasonably have anticipated the conditions encountered from a knowledgeable interpretation of the contract documents, his inspection of the site, and his general experience.”  Tucci argued that the contract “implicitly indicated that obstructions would not be encountered.” The Board rejected this logic, holding that a “contractor is not eligible for an equitable adjustment for a Type I differing site condition unless the contract indicated what that condition would be.” The Board went on to state: “We are at a loss to comprehend how the appellant  . . . could have reasonably believed it would not encounter boulders on this project.”

Rarer Than Hen’s Teeth – The Rhode Island Supreme Court Overturns Arbitrator’s Decision

By: Mike Hodgins

In a rare decision, even as the Court acknowledged repeatedly that judicial review of an arbitrator’s decision is extremely limited, the Supreme Court of Rhode Island recently vacated an arbitration award permitting a general contractor to terminate a contract for convenience. Nappa Construction Management, LLC v. Flynn, et al., 152 A.3d 1128 (R.I. 2017). The reason? Even though the agreement clearly did not give the Contractor that remedy, the arbitrator had acted outside the scope of his authority to resolve the dispute.

In 2012 the owner and general contractor entered into a contract for construction of an automobile repair facility, using a standard form AIA Contract (A101-2007). During construction there was some acrimony, which came to a head when the owner alleged defects in the concrete work, and exercised her rights to issue a stop work order until the defects were resolved. The contractor requisitioned payment for the defective work, the owner then refused payment, and the Contractor sent notice terminating the contract for cause, alleging non-payment.

The case was submitted to arbitration as required by the contract, with both parties alleging breach and damages. The arbitrator found that there was no breach, and therefore, neither party had grounds to terminate the contract for cause. But, the arbitrator went further when in the interest of ending the “dysfunctional relationship” between the parties, he held that the contractor could terminate the agreement for convenience, and awarded compensation to Contractor for work properly executed. The only problem? The termination for convenience clause of the A101 allows termination for convenience only at the option of the owner, and in this case the owner did not elect to exercise this clause. (It is important to note, the Supreme Court noted that the arbitrator’s findings were inconsistent. After finding no basis for the contractor to terminate the agreement, the contractor was itself, in effect, in breach for improper termination, yet the contractor was allowed to terminate for convenience.)

In a sharply decided decision (three judges in the majority, and two dissenting), the Court acknowledged the wealth of precedent giving broad deference to an arbitrator’s decision, and putting strict limits on judicial review of such awards. Still, the majority vacated the arbitrator’s award because he had exceeded his authority by relying upon a clause in the contract that did not exist- there is no right of the Contractor to terminate for convenience based upon the plain language of the agreement. There was no room to interpret the agreement otherwise. By substituting the arbitrator’s notion of the desirable result, and employing a remedy clearly not found in the agreement, the arbitrator “manifestly disregards a provision of the agreement” and acted beyond its terms, which included the authority to arbitrate.

The Automatic Stay: Another Lien Bites The Dust

By: Mike Bosse

A recent bankruptcy case in the Third Circuit Court of Appeals, In Re Linear Electric, highlights the intersection of a state’s mechanics lien law with federal bankruptcy statutes.  The case was decided on March 30, 2017. Fore Electrical Supply Company sold electrical materials to Linear Electric and another supplier who was involved in several construction projects in New Jersey. When the development owners did not pay Linear Electric for their work on the projects, Linear did not pay its suppliers. The suppliers were then faced with a situation in which they needed to lien the property.

Here is the problem: Linear Electric filed its voluntary petition for a Chapter  11 reorganization on July 1, 2015. That filing automatically initiated what is called in bankruptcy law the “automatic stay.” Once initiated by the bankruptcy filing, the automatic stay generally prohibits creditors from taking any actions against the debtor or its bankruptcy estate, or the property of either the debtor or the estate, without first seeking leave from the bankruptcy court. Sampson and the other supplier did not file their mechanics liens against the projects until July 15, 2015, two weeks after the bankruptcy filing. The construction company moved to dismiss the liens and the bankruptcy court agreed. The court found that the filing of the liens in the New Jersey Registry violated the automatic stay.

On appeal to the Third Circuit, the suppliers argued that the construction liens did not attach to the contractor’s accounts receivable but instead to the owners of the properties. The owners of the projects were not in bankruptcy and were different entities than the contractor who had filed bankruptcy. The contractor in turn contended that the creation of the liens was intended to collect a portion of the accounts receivable owed by the owners to the contractor who was in bankruptcy. The court concluded that because payments to the suppliers on the mechanics lien would reduce the accounts receivable of the debtor contractor, the filing of the liens against the projects did violate the automatic stay.

This case presents a difficult issue that, based on the court’s outcome, will likely result in the suppliers not being paid for the electrical materials that everyone agrees went into the various projects and increased the value of the properties. The lesson is that when an entity files bankruptcy on a construction project, the normal rules of mechanics liens may no longer apply. The automatic stay is sacrosanct in bankruptcy law and truly prevents further actions against the estate without permission of the bankruptcy court. If you are faced with being owed money from someone who files bankruptcy, you should consult with counsel to ensure that your unilateral actions do not result in an inability to collect for the work that everyone agrees was done, and to determine the best way to protect your interests, consistent with the automatic stay’s constraints.